The alternative minimum tax (AMT) can feel like a penalty for financial success. It’s hiding in the tax code ready to sweep away tax benefits for high-income taxpayers. Fortunately, the AMT brackets, exemption phaseouts and exemptions are now permanently indexed for inflation.
The AMT is made up of two tax brackets: 26% and 28%. Many deductions and credits aren’t allowed under the AMT, so taxpayers with substantial deductions that are reduced or not allowed under the AMT are the ones stuck paying. Common AMT triggers include the following:
State and local income and sales taxes, especially in high-tax states
Real estate or personal property taxes
Investment advisory fees
Employee business expenses
Incentive stock options
Interest on a home equity loan not used to build or improve your residence
Tax-exempt interest on certain private activity bonds
Accelerated depreciation adjustments and related gain or loss differences on disposition
Q: What is the AMT?
The AMT is essentially a separate tax system with its own set of rates, rules and deductions. Each year you must calculate your tax liability under the regular income tax system and the AMT, and then pay the higher amount
Q: Who typically has to pay AMT?
You generally have to pay the AMT if you use a lot of tax benefits that are not allowed against the AMT, which are detailed in our list of AMT triggers.
Q: Can I plan around the AMT?
Yes, there are ways to take advantage of the lower rates offered by the AMT, or mitigate AMT triggers. Multiyear planning is the key because you may be subject to AMT in some years and not others.
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Proper planning can help you mitigate, or even eliminate, the impact of the AMT. The first step is to work with your local Grant Thornton tax professional to determine whether you could be subject to the AMT this year or in the future. This will be easier now that the brackets and exemptions are automatically indexed for inflation. In years that you’ll be subject to the AMT, you may want to defer deductions that are erased by the AMT and possibly accelerate income to take advantage of the lower AMT rate.
Capital gains and qualified dividends deserve special consideration for the AMT. They are taxed at the same 15% and 20% rates under either the AMT or regular tax structure, but the additional income they generate can reduce your AMT exemption and result in an effective rate of 20.5% instead of the normal 15% (or 25.5% for capital gains in the 20% bracket). So consider the AMT as part of your tax analysis before selling any asset that could generate a large gain.
Planning tip: Zero out the AMT
You have to pay the AMT when it results in more tax than your regular income tax calculation, typically because the AMT has removed key deductions. The silver lining is that the top AMT tax rate is only 28%. So you can “zero out” the AMT by accelerating income into the AMT year until the tax you calculate for regular tax and AMT are the same.
Although you will have paid tax sooner, you will have paid at an effective tax rate of only 26% or 28% on the accelerated income, which is less than the top rate of 39.6% that is paid in a year in which you’re not subject to the AMT. But be careful. If the additional income falls into the AMT exemption phaseout range, the effective rate may be a higher 31.5% (because the additional income will be reducing the amount of exemption you can use). The additional income may also affect other tax benefits, so you need to consider the overall tax impact.
Planning tip: Cut down your AMT triggers
One of the best ways to lower your AMT bill is to eliminate or reduce the triggers that cause it. Real estate taxes and state taxes are not allowed against the AMT so consider postponing payment. Many people choose to prepay fourth-quarter state taxes and real estate taxes that are not due until January. You also may be able to capitalize real estate taxes held on land for investment by electing to capitalize carrying costs. This will give you a higher basis instead of a deduction that you can’t use.
Also consider reallocating your portfolio to avoid too much tax-exempt interest from private activity bonds. Compare the return to other types of tax-exempt bonds that would not potentially subject you to additional AMT.
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