In computing the Alternative Minimum Tax, a taxpayer is allowed a certain “exemption amount,” similar in concept to the standard deduction and personal exemptions allowed in calculating the Regular Tax. A surprise that hits a lot of AMT payers, however, is that this exemption amount is gradually phased out as a taxpayer’s income increases. This “hidden killer” phaseout is one of the primary reasons folks get caught in the AMT.
The exemption amount
The AMT exemption amount for married taxpayers filing jointly is $72,450 for 2010 and for 2011, and it is set at different levels for other filing statuses (see Form 6251). The exemption amount was once again “patched” in the recently-enacted tax law, effectively indexing the amount for inflation.
How the exemption works
The exemption is a subtraction from a taxpayer’s Alternative Minimum Taxable Income (AMTI), before the tax itself is calculated. As an example, if a married-filing-jointly taxpayer’s AMTI before exemption were $120,000, after subtracting the exemption this taxpayer would apply the AMT rates only to the net number – in this example, $47,550. It would be highly unlikely that this taxpayer would pay the AMT after receiving the benefit of the full exemption.
The “hidden killer” phaseout
When the phaseout applies, however, the exemption amount becomes smaller, with taxable income thus correspondingly becoming larger. For married taxpayers filing jointly, the phaseout begins at the $150,000 income level, on a “1 to 4” basis. Specifically, for every $4 of additional income above this level, the exemption is reduced by $1. Note that, as with the exemption itself, the phaseout begins at different levels for the other filing statuses.
As an example, assume a married couple had AMTI before exemption of $160,000. In this case, the exemption would be reduced by $2,500 (1/4 of $10,000). If AMTI were $200,000, the exemption would be reduced by $12,500, and so on until it is fully phased out.
No indexing of the phaseout
One of the big problems with this hidden killer is that it has never been indexed for inflation. The last major rewrite of the tax law was in 1986, when the phaseout level was set at its current levels – $150,000 for marrieds filing jointly. Today it remains at those 1986 levels, despite the very obvious fact that $150,000 is a much more easily reached income level for married couples today that it was 25 years ago.
Those who are affected
The IRS’ recently-released statistics for the 2009 tax filing season reveal the problem. At income levels up to $100,000, fewer than 1% of taxpayers are in the AMT. For income levels between $100-200,000, this increases to 6%. After this comes the real shocker – at the $200,000 level up through $500,000, 70% of the folks in this group are paying the Alternative Minimum Tax. The hidden killer is one of the main reasons for this.
What this means, unfortunately, is that working families who are far removed from the super-rich whose abuses led to the imposition of the AMT over 40 years ago, are more and more being caught in its trap. President Obama himself refers to an income level of $250,000 to separate the rich from the not-so-rich, yet a large number of individuals below this level are in fact caught by the AMT.
What can be done
Much of AMT planning focuses on the itemized deduction side of the calculation, but the income side and its corresponding effect on the loss of the AMT exemption also is a critical issue in AMT planning. Some examples of tax planning opportunities that affect income levels include the basic question of whether or not both spouses should work, whether corporate executives should defer their bonuses to a future year or exercise their stock options, or whether small business owners should accelerate or defer income. There are many others that could apply to any individual taxpayer’s situation.
An online calculator is a must in doing any AMT planning. For an excellent one that is not only easy to use but also free see http://www.amtindividual.com/alternative-minimum-tax-calculator-assistant101.html.