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AMT Triggers

Nobody enjoys paying taxes, but if you had to pick one tax that is almost universally disliked, it’s the alternative minimum tax (AMT). As with any controversial topic, there are many opinions out there about the AMT—and, unfortunately, a lot of misinformation.

What is the AMT?

The easiest way to envision the AMT is to think of it as a tax floor. Once your tax rate drops to that floor, the AMT won’t allow it to go any lower.

Originally, the AMT was intended to crack down on wealthy people who weren’t paying any income taxes. Gradually, as inflation caused incomes to rise, the middle class started to get hit with this tax. With the passage of the Tax Cuts and Jobs Act (TCJA), the AMT rules have significantly changed. The revised rules should result in far fewer people having to worry about the AMT affecting them. However, the changes are temporary and apply only to tax years 2018 to 2025 unless Congress extends them or makes them permanent. 

What are the chances the AMT will affect you?

Prior to the passage of the TCJA (tax years 2017 or earlier), if your household income was over $200,000 per year, there was about a 56% chance that the AMT would show up on your tax return, based on information provided by the IRS.¹ With those odds, many people were rightfully concerned about the AMT affecting them.

Your odds of encountering the AMT from today until 2025 are much lower, primarily because of two significant changes within the TCJA—an increase in the AMT exemptions and an increase in the phase-out thresholds. The chart below compares the prior AMT exemption to the current exemption under the TCJA.

AMT exemptions

Type of taxpayer

2017 exemption

2018 TCJA exemption

Change in exemption

Married filing jointly

$84,500

$109,400

$24,900

Single filer

$54,300

$70,300

$16,000

Married filing separately

$42,250

$54,700

$12,450

 

Along with the increased exemption, the point at which the exemption begins to phase out has been significantly increased (see the chart below).

AMT exemption phase-out thresholds

Type of taxpayer

2017 phase-out threshold

2018 TCJA phase-out threshold

Change in phase-out

Married filing jointly

$160,900

$1,000,000

$839,100

Single filer

$120,700

$500,000

$379,300

Married filing separately

$80,450

$500,000

$419,550


Once your income for the AMT hits the phase-out threshold, your AMT exemption begins to phase out at 25 cents for every dollar over the threshold. In the past, the phase-out level was quite low, and many households that wouldn’t consider themselves to be wealthy were getting affected by the AMT.

The TCJA also made changes to itemized deductions, such as reducing the deduction for the taxes you paid and removing the deduction for various miscellaneous expenses. Combined, these changes should result in the vast majority of households not having to be concerned with the AMT affecting them. That said, the AMT could still kick in if the triggers listed below apply to you.

What triggers the AMT (for tax years 2018 to 2025)?

These are some of the most likely situations: 

  • Having a high household income
    If your household income is over the phase-out thresholds ($1,000,000 for married filing jointly and $500,000 for everyone else) and you have a significant amount of itemized deductions, the AMT could still affect you.

  • Realizing a large capital gain
    Long-term gains (e.g., when you sell a home or other investments for a profit) are taxed at the same rate under both systems, but capital gains could put you over the AMT exemption threshold. That could cause the AMT to kick in, which means you won’t be able to deduct state income taxes paid on the capital gains.
  • Exercising stock options
    Exercising qualified employee stock options (also called incentive stock options or ISOs) to buy stock at a discounted price is normally not a taxable event until you sell the shares for a profit. The AMT creates a paper profit that’s taxable even though it’s not a real profit until you sell the shares.

If you’re close to the AMT thresholds, you can use IRS Form 6251 to see if you’re at risk. You can also run your own projections using tax preparation software or hire a tax professional to calculate it for you.

Depending on your income and deductions, you may find yourself affected by the AMT in one tax year, but not the next. If you’re close to the AMT threshold, it’s good practice to do a multiyear projection to see which tax years pose the most risk for you and how you might mitigate that risk. For example, you could accelerate or delay certain transactions to minimize the risk of triggering the AMT, such as determining the best tax year to sell an asset (with a large gain).

Getting hit with the AMT is unfortunate, but it’s not a reason to change your life goals. The AMT is just something to be aware of during your financial planning process—it shouldn’t keep you up at night.

¹Source: Schwab Center for Financial Research, based on information in the IRS publication “Statistics of Income–2014 Individual Income Tax Returns Complete Report” (Publication 1304), Table 1.4.

How does it work?

Let’s look at a simple example of how the AMT works.

In general, start by calculating your ordinary taxable income using IRS Form 1040. Then, use IRS Form 6251 to add back some types of income and drop certain deductions.

Be sure to include income that might be tax-free under the normal income tax system but not under the AMT. One example is interest from private-activity municipal bonds, which fund private company projects that benefit the public (like airports).

Next, remove certain tax breaks, such as deductions for state, local and property taxes paid.

Then, subtract your AMT exemption (if eligible), which for the 2018 tax year is $70,300 for individuals or $109,400 for married couples filing jointly.

Finally, compute the AMT on what’s left, compare that amount with what you would owe under the regular system, and pay the higher of the two.

A quick history of the AMT

Back in 1969, when marginal tax rates ran as high as 70% and the tax code was full of loopholes, Congress was made aware that some households with incomes over $200,000 had managed to avoid paying any federal income tax.

Congress and the public were outraged, so the AMT was designed to remove tax breaks from the wealthiest filers and force them to pay at least a minimum amount of tax. Unfortunately, lawmakers did not take into consideration the effects of inflation on the original tax law. Over the decades, as wages increased to keep up with inflation, the AMT began to affect more and more households. Congress has since fixed this flaw and now adjusts the AMT exceptions each year based on the rate of inflation, but the AMT continues to affect more than just the very rich.

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Important Disclosures

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Tax laws are subject to change, either prospectively or retroactively. Individuals should contact their own professional tax advisors or other professionals to help answer questions about specific situations or needs prior to taking any action based upon this information.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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