My accountant says I owe AMT, what is that?

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Until recently most people didn't realize that the US actually has two income tax systems: the regular tax, and the Alternative Minimum Tax (AMT). AMT taxes income at a rate of either 26% or 28%, and defines "income" differently. The tax code says, in effect, that you are liable for the taxes computed under the regular tax, or those computed under AMT, whichever is higher. If AMT is the higher one, you'll see a line added on page two of your Form 1040, showing the AMT that is tacked onto your regular income tax.

Originally AMT was created in response to a small number of taxpayers who were using various deductions to pay very little tax despite having high incomes. AMT addresses this, in effect, by changing the deductions that you're able to take when calculating taxable income. These are called "AMT preference items."

Unfortunately the tax laws describing AMT are phrased in terms of dollar amounts which were not indexed for inflation. So over time as incomes rise, more and more people have become subject to AMT. The past few years Congress has passed laws providing slight relief, by raising the amount of income you can earn before AMT begins to apply, but these have been temporary measures that don't address the main problem. Unless AMT is amended it will gradually replace the regular tax code.

Several triggers for AMT liability that have been discussed on MIFP are:

  • State and local taxes - under the regular income tax, these are valid, itemized deductions. Under AMT, however, you aren't allowed to deduct these taxes. For taxpayers in high-tax states such as New York or California, this could result in AMT liability. If you pay $15,000 in CA income taxes and another $10,000 in CA property taxes, you have $25,000 in deductions on your federal tax return under the regular tax. Under AMT, you don't have this deduction.
  • Large capital gains in a single year. While these are still taxed at the 15% rate, the gains can subject other income to AMT.
  • Exercise of Incentive Stock Options - the difference between the strike price and the fair market value of the stock on the date of exercise is an AMT preference item.
  • Having lots of kids, alongside any of the factors above.
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