The alternative minimum tax has been the bane of many middle-income taxpayers for some time. Nearly 50 years ago, the alternative minimum tax (AMT) was designed to impose a minimum tax on high-income taxpayers who were avoiding taxes by claiming legal deductions or other tax benefits—a mechanism that ensured some taxpayers didn’t escape income tax entirely. While Congress has talked about AMT reform, in the past we’ve only seen Congress kick the can down the road by raising the exemption amount every few years.
The Tax Cuts and Jobs Act made changes to medical deductions, state and local taxes, home mortgage interest, miscellaneous itemized deductions, personal exemptions, and standard deductions—some of which may have triggered AMT for the average taxpayer. Furthermore, the tax reform law increased AMT exemption amounts and significantly increased the income threshold at which exemptions phase out.
To start, all taxpayers must calculate their income tax liability the standard way. Then, taxpayers need to add some tax breaks and deductions back to their taxable income to determine AMT income. For example, take a household of a married couple filing jointly with four children. Using 2017 rules, they calculated their tax with an income of $310,000 and deductions of $42,000, which included $18,500 in state taxes, $2,500 in property taxes, $16,000 in mortgage interest, and $5,000 in charitable deductions. As a family of six, they were able to take $24,300 in personal exemptions. However, when they computed their AMT income, personal exemptions are eliminated, and they had to add back $18,500 of state and local taxes paid and $2,500 in property tax.
AMT Infographic via Henssler.com
From AMT income, they subtracted the AMT exemptions based on filing status, and then applied the AMT tax rates to calculate their AMT tax liability. If the AMT tax liability is higher than the standard tax liability, the higher amount must be paid. In our example, AMT increased their overall tax liability by roughly $6,800.
Using 2018 laws, this family only has deductions of $31,000, because state and local taxes are combined with property taxes and are limited to $10,000, while personal exemptions have been eliminated. However, they gain a child tax credit of $8,000. Under the new tax reform law, their standard tax liability calculation is $47,539. For their 2018 AMT calculation, they only must add back the combined state and local taxes and property tax deduction.
In 2018, the AMT exemption amounts have increased to $70,300 for individuals and $109,400 for married filing jointly. These exemptions function similar to a standard deduction, shielding some of your income from tax by reducing your taxable income. AMT exemptions are considerably higher than the standard deductions because of all the deductions and tax breaks that must be added back to their taxable income under AMT rules. The phaseout thresholds were also substantially increased, meaning that the full AMT exemption can be taken by individual taxpayers who earn less than $500,000 or $1,000,000 for married taxpayers filing jointly. These changes result in a 2018 AMT calculation of $38,696—far less than their 2017 AMT calculation of $62,471. However, since they must pay the larger of the two tax calculations, their tax liability for 2018 would be $47,539.
With the larger standard deductions and limited itemized deductions that the Tax Cuts and Jobs Act enacted, fewer households should itemize, making them less likely to be affected by AMT. If you are subject to AMT, you may see your AMT calculations more closely resemble your standard tax liability calculations because of the changes to how your standard tax liability is calculated and the higher exemptions for AMT.
While Congress and President Trump did not repeal the alternative minimum tax for individuals, very few middle-income households should be subject to AMT over the next decade.
William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a Certified Financial Planner™ professional.