There are a lot of abbreviations that CPAs routinely use, most of which, thankfully, aren’t part of the average person’s vocabulary. One of them, however, has become so engrained in many laymen’s lives that it sends chills up their spines each time it’s uttered.
The alternative minimum tax, or AMT, has been one of the most confusing, complex, and misunderstood sections of tax law since its introduction in 1979. Its original purpose was to ensnare taxpayers with high income levels who employed loopholes to pay little or no income tax.
While Congress was successful in its original mission, subsequent changes in tax law resulted in nuances between regular vs. alternative minimum tax which exposed increasing numbers of unsuspecting taxpayers to AMT. The number of individuals affected by this behemoth increased from fewer than 1 million through the late 1990s to approximately 5 million in 2017.
Tax Cuts and Jobs Act to the Rescue
Many individuals, including myself, were pleasantly surprised to learn that the House and Senate proposals of the Tax Cuts and Jobs Act contained a repeal of the almost 40-year-old AMT. The repeal, like most changes in the new tax law, would have only been effective from 2018 through 2025.
As part of the final negotiations, however, the AMT was retained to reduce the perception of the new tax law favoring high incomers. The number of taxpayers affected by AMT is expected to be reduced from 5 million to 200,000 as a result of two favorable changes: (a) a sizable increase in the AMT exemption amount and (b) a substantial increase in the income level at which the exemption phases out.
Whereas the 5 million individuals who paid AMT in 2017 tended to earn $200,000 to $600,000, the estimated 200,000 taxpayers subject to the tax going forward are likely to have much higher incomes.
AMT Exposure Minimized for Most Individuals
I recently spent several hours testing the new AMT calculations in my tax planning software and came to the following three general conclusions regarding the likelihood of paying AMT under the new tax law:
- You will pay no AMT if your only source of income is ordinary income.
- Your maximum AMT exposure will be $2,400 if single or $4,800 if using married filing joint status if your only source of income is long-term capital gains.
- Most taxpayers who will pay AMT will have a relatively high combined level of ordinary income and long-term capital gains, with long-term capital gains exceeding ordinary income.
AMT Planning Eliminated for Most
In addition to higher levels of taxable income, various types of deductions historically increased one’s likelihood of paying AMT. These included state and property tax deductions, personal exemptions, and miscellaneous itemized deductions. State and property tax deductions have been reduced to a combined total of $10,000 under the new tax law while personal exemptions and miscellaneous itemized deductions have been repealed.
The reduction or elimination of the foregoing “tax preference items” combined with an increased AMT exemption amount and a smaller likelihood of phaseout of the exemption, will result in a reduced need for AMT planning. As stated above, there will be isolated situations where AMT can still come into play. In addition to those mentioned, incentive stock options will continue to increase one’s exposure to AMT.
Chronic AMT Taxpayers Granted a Reprieve
Many individuals who paid AMT in 2017 have been subject to this dreaded tax for years. Although AMT wasn’t eliminated as originally promised, chronic AMT taxpayers have finally been granted a reprieve by the new tax law – at least through 2025.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.