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The alternative minimum tax (AMT) is one of the least understood and most controversial parts of the federal income tax system of the United States. It is an extra tax some people have to pay on top of the regular income tax and it is used to recapture their tax liability and some tax benefits.
Any taxpayer whose income exceeds a specified level, based on his or her filing status, is required to compute tax owed under both the regular income tax and AMT systems, and is liable for whichever amount is higher. It is therefore an alternative – albeit mandatory alternative – method for calculating one's taxes.
Initially, AMT was introduced to prevent people with very high incomes from using special tax benefits to pay little or no tax and to make sure that these taxpayers paid at least a minimum amount of tax. However, because AMT is not automatically updated for inflation, more middle-class taxpayers are becoming subject to it. Due to this fact, a provision was included in the latest stimulus package passed by Congress to at least temporarily raise the income threshold for AMT liability.
The Difference between Alternative Minimum Tax and Regular Tax
The AMT has a completely different set of calculations than the regular tax. When calculating regular tax, you add up your total income, subtract various deductions and personal exemptions, and then calculate the tax. With the regular tax, you can also claim various credits to reduce your tax even further. AMT rates start at 26% and move to 28% at higher income levels while regular tax rates start at 10% and then move through a series of steps to a high of 35%.
The AMT, however, does not allow the standard deduction, personal exemptions, or certain itemized deductions. Also, some income which is not subject to the regular tax is added for AMT purposes. Your tax under AMT rules may therefore be higher than your tax under regular tax rules. The AMT determines the minimum amount of tax someone with a specific income should pay. If this person is paying that much already with regular income tax, he or she will not be subject to paying AMT. If, however, that taxpayer's regular tax falls below the minimum, he or she has to make up the difference by paying the alternative minimum tax.
Determining How Much AMT to Pay
After calculating your taxes using both methods, you will need to compare the amount you need to pay according to regular income tax and the amount according to the alternative minimum tax. If the regular tax amount is higher, then you are not liable to pay any AMT. However if the regular tax is lower, then the difference between the two amounts will be the AMT you will have to pay.
For example, if your regular income tax is calculated at $1,025 and your alternative minimum tax amounts to $1,500, you will be liable to pay a difference of $475. If however, your regular income tax is $1,500 and your alternative minimum tax is $1,025, you will not be liable to pay AMT.
On a more positive note, an AMT credit can also reduce your taxes in years after the year you paid the alternative minimum tax. This is applicable if you paid AMT because of certain "timing items" such as exercising incentive stock options.
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