Established in the 1960's the Alternative Minimum Tax (AMT) is the federal government's way of prohibiting extremely rich citizens from not paying taxes. The impetus for the tax's creation was the Internal Revenue Service's (IRS) realization that volume of deductions and credits available to taxpayers with the largest incomes in the nation often resulted in their having no tax liability. To prevent these individuals from avoiding taxes altogether, the government established the AMT.
A Brief Overview of the AMT
The tax requires that individuals, corporations, trusts and estates with AMT calculations that exceed their traditional income tax liability calculations pay a percentage of the difference. It is not an additional or alternative to regular income taxes, but rather an entirely different way of calculating liability.
There is no minimum income amount which places the AMT into effect. Instead, taxpayers or the representatives of a corporation, trust or estate are required to determine whether the AMT applies to them by completing both their regular tax form (such as a 1040) and Form 6251, titled "Alternative Minimum Tax - Individuals". If the estimated amount of tax liability on the tax form is less than the estimated amount of AMT, the taxpayer must pay a percentage of the difference between the two. Generally, the IRS charges 26 percent on the difference for the first $175,000 of difference between the two for single or the first $87,500 for married taxpayers filing separately. The IRS charges 28 percent on the remaining amount above those limits.
The AMT is unavoidable. In fact, failing to pay the AMT when you owe it may result in penalties, fines and interest being assessed against you. Because of this, the Wall Street Journal recommends that taxpayers earning more than $75,000 a year complete Form 6251 to ensure that they do not owe the AMT. Completing the form is also recommended for business owners and individuals who exercised stock options within the last year.
The tax fulfills its intended job of ensuring that extremely wealthy people pay their share of taxes. In fact, many of them recognize their need to pay it as a fact that they will have to pay it and choose to plan their finances around it rather than try to avoid it.
If you are not a big-time investor or business owner, however, you may still need to pay the AMT. Currently, because it does not adjust for inflation, the majority of taxpayers affected by the tax are dual-income families with two or more children. Roy Lewis, author and contributor to the MotleyFool.com, identifies six typical situations causing AMT liability for non-business owner taxpayers:
- A large number of personal exemptions;
- Large amounts of state and local taxes;
- Large capital gains
- Selling Incentive Stock Options
- Large medical expense deductions
- Large amounts of itemized deductions.
Lewis' advice is to thoroughly research the AMT and your finances and complete Form 6251 before the tax deadline.
The AMT Assistant
The IRS operates and offers an AMT Assistant to the general public through its website. This Assistant helps taxpayers determine whether they are subject to the AMT. It requires that the taxpayer enter information from their estimated tax return and, once complete, tells the user whether they are not subject to the AMT or if they must complete Form 6251.
The Assistant is anonymous and confidential. Because of this, it is a valuable tool for taxpayers wanting to know their tax liability without having to complete paper forms if it is unnecessary to do so.
Determining Your Tax Liability
Don't hesitate to determine if you are subject to the AMT; doing so could result in significant penalties. Seek legal or financial advice if you are uncertain about how to estimate your tax liability.