Alternative Minimum Tax: Know the Deal

The alternative minimum tax or AMT is more than a mere tax: It disallows or reduces exemptions and deductions that would otherwise work to your benefit. Forbes calls it the normal tax system’s evil twin.

You may think your children entitle you to exemptions or that your property taxes will earn you a deduction; however, AMT could have a whopping tax bill knocking at your door.

The calculation happens behind the scenes — either at your accountant’s office or behind the screen if you couple that with tax software. Unfortunately, you may not even know what hit you.

What happens is that your tax liability is determined both with and without the AMT, and you will pay whichever amount is higher. Taxpayers with incomes between $200,000 and $500,000 appear to be the most vulnerable.

AMT was created in 1969 to ensure that very wealthy taxpayers pay their fair share, but now AMT ensnares millions of upper-middle-class Americans. Though tax experts and elected officials decry the irony of AMT, it lives on. And why? You guessed it — because it brings in so much revenue: close to $30 billion in 2015, according to the Tax Policy Center.

Can you lessen AMT’s impact? Try these suggestions:

  • Max out your 401(k). Contribute as much as you’re legally allowed to a 401(k) or similar plan. This can reduce your adjusted gross income.
  • Be strategic in paying taxes. You may be prepaying property taxes to increase your deductions, but that may not always be a good idea: The AMT may disallow your property tax deduction entirely, negating any benefit.
  • Time your stock options. If you take and provide incentive stock options that allow managers and/or staff to buy company stock at a fixed and often bargain price, you may not face any tax until you sell. But if the AMT kicks in, you’ll owe taxes on the difference between the shares’ value and what you paid for them, even if you don’t sell them. But if you do have to pay the AMT on your stock options, you may be eligible for a credit in a future year when the AMT doesn’t kick in.
  • Be careful with home equity loans. The AMT generally lets you deduct the interest only if you use the money for home improvements. This is another case when you should consider scenarios both with and without a tax deduction, just in case AMT rears its ugly head.
  • File a Schedule C if you can. If you have self-employment income and file a Schedule C — Profit or Loss from Business — with your tax return, that may help lighten your AMT load.
  • Consider a partial Roth IRA conversion. If your income normally is taxed at 39.6 percent, try a cheap Roth conversion: The money you convert would be taxed at the AMT rate of 28 percent instead.

Remember that withdrawals from a Roth are tax-free and a Roth isn’t subject to the government’s required minimum distributions once you reach age 70 1/2, so if you don’t need the money, you can pass it along to your heirs.

The AMT is complex and rules may change, so be sure to speak with a qualified professional before making a decision.

To receive our monthly newsletter, sign up here.