What is the Alternative Minimum Tax?

 

If you think that your tax return is complicated today, just wait a few tax years. More and more middle class families are finding that they are subject to the alternative minimum tax on their tax returns - which was originally designed to charge an additional tax on certain tax preference items commonly deducted by the rich on their tax returns.

The tax laws give preferential tax treatment to certain kinds of income and allow special tax deductions and tax credits for some kinds of expenses on tax returns. The alternative minimum tax attempts to ensure that all individuals who benefit from these tax advantages will pay at least a minimum amount of tax on their tax return. The alternative minimum tax is a separate tax computation that, in effect, reduces the tax benefit of certain tax deductions and tax credits on your tax return, thus creating a tax liability for an individual who would otherwise pay little or no tax on his/her tax return.

The alternative minimum tax is particularly effective in ensuring people pay some minimum amount of tax to the IRS after they've taken advantage of tax credits and tax deductions on their tax return. Some middle income families may find the$1,000 Child Tax Credit and college tax credits will force them to calculate alternative minimum tax

You may have to pay the alternative minimum tax on your tax return if your taxable income for regular tax purposes, plus any of the adjustments and tax preference items that you took on your tax return, is more than a specified exemption amount.

The following items are subject to the alternative minimum tax

  • accelerated depreciation in excess of straight line depreciation;
  • circulation expenses;
  • depletion;
  • foreign tax credit;
  • income from long term contracts computed under the percentage of income method;
  • income from the exercise of incentive stock options;
  • intangible drilling costs;
  • installment sale income (certain types);
  • interest on home equity debt used for non-residential purposes;
  • investment expenses;
  • itemized tax deductions for tax, medical expenses, and miscellaneous expenses;
  • mining exploration and development costs;
  • net operating loss tax deductions;
  • passive income or loss tax deductions;
  • personal tax exemptions;
  • pollution control facility amortization;
  • research and experimental expenses;
  • small business stock gains that qualify for the 50% tax exclusion;
  • standard tax deduction;
  • tax exempt interest from private activity bonds;
  • tax shelter farm income or loss.

The alternative minimum tax is a separate and parallel tax system directed at taxpayers who pay little or no regular tax on their tax return because of the use of certain tax deductions. There are no "tests" to determine whether you are subject to the tax on your tax return. You must calculate your tax liability both ways on your tax return.

The individual alternative minimum tax rate is 26% on all alternative minimum taxable income in excess of an exemption of up to $70,950 on a joint tax return, $46,700 for a single or head of household person's tax return, and $33,475 for married persons who file separate tax returns. The rate is 28% starting at $175,000 ($87,500 for married persons who file separate tax returns) of alternative minimum taxable income in excess of the exemption.

Here's how to calculate the alternative minimum tax on your tax return:

 

 
  • Determine if you took a tax deduction that would require you to calculate the alternative minimum tax

 

  • Complete Form 6251 to see if you owe alternative minimum tax.

 

  • On this form, you calculate your income under the alternative minimum tax formula. You add back to your income special tax benefits, so-called "tax preference items," such as child tax credits.

 

  • You subtract from this alternative minimum tax income the exemption shown above. The result is taxed at 26% for a couple's first $175,000 in income; 28% above that.

 

  • If the resulting alternative minimum tax exceeds the regular tax on your tax return, an alternative minimum tax liability equal to the difference results.

Alternative Minimum Tax Credit

If an alternative minimum tax liability occurs because of certain tax deductions or tax credits not fully allowed for alternative minimum tax purposes (non-exclusion preferences), the alternative minimum tax credit can be used to decrease regular tax liability in a later tax year on your tax return. In most cases, this alternative minimum tax credit reduces the impact of the alternative minimum tax by effectively refunding some or all of the alternative minimum tax paid on your tax return. Thus, in some cases, alternative minimum tax planning may be a matter of timing-payment of alternative minimum tax now and reducing regular tax on your tax return in the future.

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