In a twisted plot to take back the tax breaks it provides, Congress created the alternative minimum tax (AMT). Initially, the AMT was intended to prevent higher-income taxpayers from substantially reducing or eliminating their tax liabilities through incentives offered by the tax code. In practice, however, the AMT affects even middle-income taxpayers because the AMT exemption amounts have traditionally not kept up with inflation. For example, the exemption rates set in 1992 were not increased until 2001.
As a result, many taxpayers are required to compute their income tax liability twice: once under the regular method and once again under the AMT method. An individual will be subject to the AMT if his or her AMT liability is more than the regular tax liability for the year.
What types of things can trigger the AMT? The most common items that can cause you to become subject to the AMT are listed below. These items must be added back to your taxable income in order to compute your AMT:
- all personal exemptions
- the standard deduction, if you claimed it
- itemized deductions for state and local income taxes, and real estate taxes
- itemized deductions for home equity loan interest (this does not include interest on a loan to buy, build, or improve your home)
- itemized deductions for miscellaneous deductions
- itemized deductions for any portion of medical expenses that exceed 7.5 percent of AGI but not 10 percent of AGI
- deductions you claimed for accelerated depreciation that exceed what you could have claimed under straight-line depreciation
- differences between gain or loss on the sale of property for AMT purposes and for regular tax purposes; these differences most commonly occur as a result of the different depreciation methods required under AMT, as described above
- addition of certain income from incentive stock options
- changes in income from installment sales, since the installment sale method generally can’t be used for AMT purposes
- changes in certain passive activity loss deductions
- deductions relating to oil and gas investments, or drilling or mining operations
- interest on certain private activity bonds that would otherwise be tax-exempt
If you have large amounts of any items on this list, and your adjusted gross income exceeds the exemption amounts discussed below, you (or your accountant) should compute your AMT liability on IRS Form 6251, Alternative Minimum Tax — Individuals, to determine whether you must actually pay any AMT.
In an additional twist to this very complicated area, there is a tax provision that gives taxpayers back what the AMT otherwise takes away. Through the end of 2007, taxpayers may use nonrefundable personal credits to offset AMT liability. Nonrefundable personal credits include the dependent care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit.
Planning Tools:
You can download Form 6251 to aid in your financial planning.
Children under age 18 who have investment income of more than $6,300 in 2007 should also complete Form 6251 to see whether they owe any AMT.
If AMT potentially applies to you, you need to know about the following:
