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Tax Relief 101 – Understanding Alternative Minimum Tax

Posted By Jim On 02/23/2005 @ 4:10 pm In Taxes | 1 Comment

This is the fourth post a series of Tax Relief advice articles, you can see the whole collection under the category of Tax Relief 101 [3].

If you’re like me, you’ve heard about this ugly Alternative Minimum Tax (AMT) monster that will come and make you pay more taxes. And just like me, you know nothing about it. In this installment of Tax Relief 101, the AMT monster will be explained so you understand why it’s here and what it means for you.

Background: Back in the days of yore, a lot of high-income folks were finding very creative ways to get out of paying as much tax as they were expected to. The government obviously found this very frustrating so they created an alternative set of rules to assess tax liability because they felt that at a certain level of income, you should pay at least a certain amount. The AMT is simply your tax liability calculated by those alternate rules and but it’s starting to apply for more people than before and it’s pissing all those people off.

Basics: When you’re doing your taxes, you’ll arrive at a number which is how much in taxes you will pay for last year. It will be higher than what you wanted to pay. Then, you calculate how much you would pay according to the AMT rules and what you owe is the larger of the two numbers (awesome!). Technically, you pay your regularly-computed tax and then the difference between that and the AMT is considered your AMT.

How To Calculate:
Easy Way: Get some good tax software and it will calculate it for you.
Hard Way: You can compute your AMT using Form 6251 [4] which you can download from IRS.gov [5]. Just get the software.

So basically AMT is Congress’ way of getting you to pay a minimum amount, even if you have completely legal deductions that would reduce your tax liability! Is there anything you can do? No, unless Congress changes the rules. The only good news is that a portion of your AMT can be credited back to you in future years. This is how you do it:
1. Figuring Available Credit – First you need to figure out how much of the AMT you paid the year before is eligible to come back and help you this year. You need to figure how much of the AMT from that year is the result of timing issues, that is anything you did to delay reporting income as opposed to something that just reduced your reportable income. You can use Form 8801 [6] to figure out how much credit is eligible.
2. Figuring How Much Credit You Can Use – Then, after you’ve figured how your regular tax and AMT for this year, you can use any available credit from the prior year to cover the difference between regular tax and AMT if your regular tax is greater!

Example: In 2004, you owe $10,000 in regular tax and $8,000 according to the AMT, thus your tax liability for 2004 is $10,000. You calculate that you have $4,000 in credit from the AMT from 2003. You may use $2,000 of that credit, the difference between regular and AMT, and apply it towards your tax liability of $10,000 so that you only owe $8,000 of tax for 2004.

So basically, high-income people were pushing off their income to be taxed in a later year so Congress created the AMT to capture the tax this year and give them credit next year when they do report it. It’s a interest-free loan from your pocket to the US Government. The downside is that now it’s affecting people without high-incomes who are taking deductions they should be taking.

Ultimately, what this means to you is that you need to do more math (or your tax program/accountant does more math), but at least now you have an inkling as to why you need to do more math.

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[3] Tax Relief 101: http://www.bargaineering.com/articles/tag/tax-relief-101

[4] Form 6251: http://www.irs.gov/pub/irs-pdf/f6251.pdf

[5] IRS.gov: http://www.irs.gov

[6] Form 8801: http://www.irs.gov/pub/irs-pdf/f8801.pdf

Thank you for reading!