What is the AMT?
Congress introduced the AMT in 1969 as a way to ensure that certain wealthy individuals paid their fair share of income tax. The impetus for the AMT was the belief that various loopholes in the tax code created an unfair advantage for wealthy taxpayers, allowing them to reduce their tax bills.
In 1986, the entire Internal Revenue Code was overhauled, eliminating virtually all the loopholes that prompted the introduction of the AMT. Yet the AMT remained law, perhaps because it accounts for billions of dollars in extra tax revenues every year.
How does the AMT work?
The AMT requires you to include income from certain sources that ordinary income tax lets you exclude—for example, interest from private activity municipal bonds and the spread on the exercise of incentive stock options.
The AMT system takes away or reduces certain tax breaks, including:
- Your personal exemption.
- Dependent exemptions. Under the regular income tax system, most taxpayers can claim a $4,050 exemption for themselves, their spouses, and each dependent for 2016. This exemption is not allowed under the AMT. Someone who is married and has four children, for example, may be out deductions amounting to thousands of dollars under the AMT.
- Deductions for state and local taxes paid. Do you live in a high-tax state? The AMT doesn’t allow you to claim a deduction for state income or property taxes, so if you’re in a state with high taxes you could be more exposed to the AMT than someone in a state with lower tax rates.
- Deductions for interest on home equity loans not used to improve your home. Interest on home equity loans of up to $100,000 is deductible under the ordinary tax system. Under the AMT, it’s only deductible if you use the loan proceeds to finance a home purchase or make capital improvements to your primary or secondary residence. If you use a home equity loan to pay for college or buy a car, you cannot deduct the interest.
- Miscellaneous itemized deductions.
- Exercising qualified employee stock options. Exercising such an option, often called an incentive stock option, or ISO, to buy stock at a discount to the market price creates a paper profit that’s taxable under the AMT, even though it’s not a real profit until you sell the shares.
For more comprehensive information, see IRS Form 6251 PDF.
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