Daily Deduction: Unraveling the Alternative Minimum Tax

In 1969, Congress was fed up. A handful of the wealthy weren’t paying their dues. By taking advantage of tax breaks meant to help working class families and small business owners, these lucky few were able to reduce their tax bills to almost nothing. In response to what it perceived as an injustice, the government created the alternative minimum tax. It was meant to reach only the truly rich.

Commonly referred to as the AMT, the tax will mark its fortieth anniversary this year, and like the rest of its generation, it has grown up and expanded its horizons. Once aimed at only a privileged minority, it is now firmly ensconced as a tax on the middle class. That is because, unlike the rest of the tax code, the income limits of the AMT do not move with the ebb and flow of currency fluctuation. The level of income exempt from the AMT has remained at its decades-old level while the rest of us have risen on a steady tide of inflation. As a result, unless Congress changes the tax law or deflation takes hold of our wage structure, the AMT will reach ever lower into our strata of income until it eventually supplants the currently prevailing tax system.

Like other tax issues that touch the middle class, the AMT has become a perennial favorite of would-be legislators who promise change. Why, then, hasn’t it been amended? The truth is that the AMT’s broad scope generates a tremendous amount of income for the federal government. It is a behind-the-scenes revenue raiser that allows Congress the luxury of passing more visible and popular tax cuts, like the hybrid vehicle credit or the student loan interest deduction. Although there have been a number of temporary patches to the AMT, they have been modest in scope, and after a couple of Congressional tries, a permanent fix for middle class taxpayers has remained elusive.

Perhaps this is because, despite the abundance of political talk about the AMT, very few people understand how it actually works. The AMT isn’t just a random dollar amount that gets added to your federal tax bill if you earn too much money; it is an entirely separate calculation of tax. If your AMT calculation produces more tax than your regular calculation, you are required to pay the AMT. If your regular calculation produces more tax than the AMT, you are required to pay the regular tax. For the taxpayer, it’s a lose-lose situation.

Like the regular tax calculation, the AMT starts with your income, but unlike the regular calculation, it allows very few deductions or adjustments. Instead, it has a fixed “exemption amount.” The first $46,200 that you earn are exempt from the alternative minimum tax if you file as an individual. If you file jointly with your spouse, the exempt amount is $69,950. So if you earn $100,000 and file a joint return, $30,050 may be subject to tax at the AMT rate. What, you ask, is the AMT rate? It’s 26% for income that is $175,000 or less, and 28% for anything above that amount. But be careful. Not everyone can claim the exemption amount. If your income is more than $112,500 and you’re single, or if your income is more than $150,000 and you’re a joint filer, your exemption will be reduced or eliminated, which is not a thrilling prospect, because it exposes even more of your income to the AMT.

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