For years, there has been much confusion and concern surrounding the Alternative Minimum Tax (“AMT”). This has been largely due to the disparity between those who have been subject to the tax, and the original intent of the law. The overarching problem is that the AMT tax calculation has never been permanently indexed for inflation, and as wages have increased over time, millions of middle-income taxpayers have been unwittingly ensnarled by the tax. However, the American Taxpayer Relief Act of 2012 remedies this problem.
To define, AMT is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. The tentative minimum tax is calculated by taking one’s taxable income, modifying it using adjustments (e.g., adding back certain itemized deductions), and then subtracting an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is then multiplied by an AMT rate of 26% or 28%.
When Congress established the AMT in 1969, the original purpose of the AMT was to ensure that affluent taxpayers, who overly benefited from various income exclusions, deductions and credits, pay at least a minimum amount of tax. Since the tax was imposed by the federal government, it had never been permanently indexed for inflation.
Intermittently over the past several decades, Congress has developed temporary solutions in the form of AMT “patches,” which are the income exemption amounts used to reduce AMTI. In spite of these temporary “patches,” many felt that these weren’t really a solution at all. The AMT had seemed to progressively deviate from its original intent, as it subjected an increasingly large number of middle-class income taxpayers to the minimum tax (versus affluent taxpayers, for whom the tax was originally intended). However, on January 1, 2013, The American Taxpayer Relief Act of 2012 includes provisions that should alleviate concerns about AMT.
The Act contains two key provisions that provide AMT relief for individual taxpayers, retroactively effective for tax years beginning after 12/31/2011. The first delineates that the AMT exemption amounts have been permanently increased, and indexed for inflation. The exemption amounts vary depending on filing status, and are as follows:
- Married Filing Jointly or Qualifying Widow(er) with Dependent Child: $78,750, less 25% ofAMTI exceeding $150,000 (zero exemption when AMTI is $465,000, or greater)
- Single or Head of Household: $50,600, less 25% of AMTI exceeding $112,500 (zero exemption when AMTI is $314,900, or greater)
- Married Filing Separately: $39,375, less 25% of AMTI exceeding $75,000 (zero exemption when AMTI is $232,500, or greater). But AMTI is increased by the lesser of $39,375 or 25% of the excess of AMTI (without the exemption reduction) over $232,500.
The second key provision provides that nonrefundable personal tax credits may be used to offset both AMT and regular tax liability (e.g. child tax credit, residential energy credit, etc.). Previously, these tax credits were not able to offset tax liability if the taxpayer was in AMT, resulting in the credits being carried forward in perpetuity, and thus giving no benefit to the taxpayer.
These tax provisions included within The American Taxpayer Relief Act of 2012 will relieve millions of taxpayers from AMT, particularly those within the middle class, by either reducing or eliminating the tax altogether, and simultaneously refocus the tax back on affluent taxpayers. From a tax planning standpoint, it is important for taxpayers who anticipate remaining in AMT to consider avoiding items that aren’t exempt/deductible for AMT purposes (e.g. investments in private activity bonds, prepayment of real estate, state and local taxes, etc.)