Alternative Minimum Tax (AMT): Who qualifies and how to save on taxes

The alternative minimum tax (AMT) is a tax levied on higher earners that ensures they pay a certain amount of their income in taxes, regardless of the number of credits or deductions they receive. Even if your ordinary income tax is lower, you’ll still have to pay the AMT.

What is the Alternative Minimum Tax (AMT)?

An alternative minimum tax is a floor on the effective tax rate paid by taxpayers to the government. A filer can claim a host of deductions that would, in theory, result in a lower or zero tax rate — but under an alternative minimum tax, they’d still owe a certain amount in taxes. In other words, it’s a certain percentage of your taxable income that you owe, regardless of your deductions or other credits.

The first AMT was enacted in the US in 1969 as an add-on tax of 10%. Today, it’s simply a minimum tax rate for federal income tax that high earners have to pay. In the IRS’s terms, it’s a tentative minimum tax that’s applied over ordinary income tax.

The goal of the AMT in the US is to ensure that higher earners pay their fair share, as deductions and other credits can disproportionately affect these brackets. For those who qualify, the IRS recalculates their taxable income by accounting for certain tax preference items that would otherwise be deductible. Several other deductions are added back in to create the alternative minimum taxable income, from which the AMT is derived.

Parallel tax

The AMT is a parallel tax to the ordinary tax system, meaning that it functions separately from the normal tax framework. Most filers who qualify will calculate different amounts for the AMT and ordinary tax and must pay the higher of the two amounts.

Bracket creep

In its original form, the AMT was not set up for other issues in the tax system, such as inflation or other tax cuts. This led to something called bracket creep, where people in middle-class tax brackets were subject to the tax, which is only supposed to apply to wealthy taxpayers. In 2012, Congress passed a law that pegs the AMT exemption limit to inflation.

Standard Deductions

In addition to a higher marginal tax rate, one of the most important AMT rules applies to standard deductions. Standard deductions are a certain amount of income that is tax-exempt, assuming you don’t use itemized deductions. Individuals who qualify for the AMT are also ineligible to receive the standard deduction. Other personal exemptions, like deductions for state and local taxes, are also not permitted.

Who has to pay the AMT?

Only high-income taxpayers need to pay the alternative minimum tax. If you do not qualify for the AMT, you can pay the regular tax at your usual tax rate and take advantage of any deductions.

The tax is applied through an exemption-based process — if your income is lower than the AMT Exemption for that year, you aren’t eligible for the AMT. However, those with an AMTI over a certain amount must pay the alternative minimum tax, regardless of their income. The phase-out begins at $539,000 for single filers and $1,079,800 for married couples filing jointly in 2022. In 2023, those numbers will increase to $578,150 for single filers and $1,156,300 for joint filers.

AMT Tax Rates

There are two tax rates for the alternative minimum tax — 26% and 28%. The amount you pay is based on your AMTI.

AMT tax rates based on AMTI

Unless you are a high earner, there is a strong chance you don’t qualify for the AMT. The Tax Cut and Jobs Act (TCJA) of 2017 implemented tax reforms that reduced the number of taxpayers eligible for the AMT plummeted. Today, just 200,000 tax payers in the US qualify for the AMT, according to estimates by the Tax Policy Center.

What is the AMT Exemption for 2022 and 2023?

Most low and middle-income American taxpayers won’t need to worry about the AMT on their tax bill. That’s because you’re automatically exempt from the alternative minimum tax if you qualify for the AMT Exemption. The AMT exemption amounts for 2022 and 2023 are:

If your income is below this threshold, you’ll pay federal income tax at your ordinary income tax rates. Note that the AMT Exemption (and AMT in general) apply only to federal taxes — local tax rates may differ.

Calculating AMT

Taxpayers can calculate whether they owe AMT by filling out IRS Form 6251. Most tax software can also perform this calculation. Tax law is incredibly complex and you should consult with a tax professional if you are unsure about your situation and whether AMT applies to you.

Eligibility for tax breaks and the AMT

Taxpayers often look forward to tax breaks, credits, and other tax deductions as a way to reduce their taxable income. However, if you qualify for the AMT, certain tax breaks disappear because you’re subject to new tax rules. These include state and local taxes, which can’t be deducted under the AMT. The number of business expenses you can deduct also shrink, which could raise your taxable income.

This is particularly important for investors, who can face AMT if their long-term capital gains or dividends and other distributions bump up their income in the AMT system. If you need to calculate your capital gains, check out Public’s capital gains calculator.

How can you avoid the AMT?

The only way to avoid paying the AMT is to ensure that your income stays below the AMT exemption or AMTI maximums. Of course, that’s not always possible. In these cases, finding out whether you are at risk of paying the AMT is highly useful.

At that point, there are several strategies you can use to lower your adjusted gross income on your income tax return and ensure you’re below the threshold where you qualify for the AMT. These include maxing out contributions to your 401(k) or traditional IRA, as well as contributing to health savings plans. Tax-loss harvesting may also impact your AGI.

For individuals who are abroad, applying the Foreign Tax Credit can lower your regular tax liability and thus reduce the income that qualifies for AMT.

ISOs

If you receive incentive stock options (ISOs) from your company and choose to exercise them, you may have to factor this into your AMT calculation. Although ISOs are not subject to ordinary income tax, they do qualify under the alternative minimum tax.

Capital gains

For investors, keeping an eye on long-term capital gains can help you avoid AMT liability. Remember that this can also apply to your taxes on your crypto investments. Public can help you keep an eye on the market with its exclusive market content. And with Public’s automatic dividend reinvestment tool, you can avoid the kind of liquidity that affects your eligibility for AMT.