New Law Eases the Individual Alternative Minimum Tax

Unfortunately, the Tax Cuts and Jobs Act (TCJA) retains the individual Alternative Minimum Tax (AMT). But there’s a silver lining: The AMT rules now reduce the odds that you’ll owe the AMT for 2018 through 2025. Plus, even if you’re still in the AMT zone, you’ll probably owe less AMT than you did under the old rules.

Why the AMT Hits Upper-Middle-Income Taxpayers

Under prior law, many high-income taxpayers weren’t affected by the AMT. That’s because, after numerous legislative changes, many of their tax breaks were already cut back or eliminated under the regular income tax rules. So, there was no need to address the AMT. For instance, the passive activity loss rules restrict the tax benefits that can be reaped from “shelter” investments like rental real estate and limited partnerships.

If your income exceeds certain levels, you run into phaseout rules that chip away or eliminate other tax breaks. As a result, higher-income taxpayers had little or nothing left to lose by the time they got to the AMT calculation, while many upper-middle-income folks still had plenty left to lose. Also, the highest earners were in the 39.6% regular federal income tax bracket under prior law, which made it less likely that the AMT — with its maximum 28% rate — would hit them.

In addition, the AMT exemption is phased out as income goes up. This amount is deducted in calculating AMT income. Under prior law, this exemption had little or no impact on individuals in the top bracket, because the exemption was completely phased out. But the exemption phaseout rule made upper-middle-income taxpayers even much more likely to owe AMT under prior law.

Under the TCJA, upper-middle-income people are somewhat less likely to owe the AMT, and if they do, their AMT liabilities are likely to be lower.

Here’s what you need to know about the new-and-improved AMT rules for 2018 through 2025.

Important note: The prior law version of the AMT still applies for your 2017 income tax return, which is due on April 17, 2018.

The Basics

Think of the AMT as a separate tax system that’s similar to the regular federal income tax system. The difference is that the AMT system taxes certain types of income that are tax-free under the regular tax system and disallows some regular tax deductions and credits.

The maximum AMT rate is 28%. By comparison, the maximum regular tax rate for individuals was 39.6% for 2017 under prior law. The maximum regular tax rate for individuals is reduced to 37% for 2018 through 2025 thanks to the TCJA.

For 2017, the maximum 28% AMT rate kicks in when AMT income exceeds $187,800 for married joint-filing couples and $93,900 for others. For 2018, the maximum 28% AMT rate starts when AMT income exceeds $191,500 for married joint-filing couples and $95,750 for others.

Inflation-Adjusted Exemption

Under the AMT rules, you’re allowed a relatively large inflation-adjusted AMT exemption. This amount is deducted when calculating your AMT income. The TCJA significantly increases the exemption for 2018 through 2025. The exemption is phased out when your AMT income surpasses the applicable threshold, but the TCJA greatly increases those thresholds for 2018 through 2025.

If your AMT bill for the year exceeds your regular tax bill, you must pay the higher AMT amount. Originally, the AMT was enacted to ensure that very wealthy people didn’t avoid paying tax by taking advantage of “too many” tax breaks. Unfortunately, the AMT also hits some unintended targets. (See “Why the AMT Hits Upper-Middle-Income Taxpayers” at right.) The new AMT rules are better aligned with Congress’s original intent.

Key Figures

The following table summarizes the AMT exemptions and phaseout thresholds for 2017:

Unmarried individuals
Married couples who file jointly
Married individuals who file separately

AMT exemption amount
$54,300
$84,500
$42,250

Phaseout starts at
$120,700
$160,900
$80,450

Completely phased out at
$337,900
$498,900
$249,450

The following table summarizes the AMT exemptions and phaseout thresholds for 2018:

Unmarried individuals
Married couples who file jointly
Married individuals who file separately

AMT exemption amount
$70,300
$109,400
$54,700

Phaseout starts at
$500,000
$1 million
$500,000

Completely phased out at
$781,200
$1,437,600
$718,800

Under both old and new law, the exemption is reduced by 25% of the excess of AMT income over the applicable exemption amount. But under the TCJA, only those with really high incomes will see their exemptions phased out, while others (including middle-income taxpayers) will benefit from full exemptions.

Risk Factors Before and After the TCJA

So, who will be hit by the AMT? Various interacting factors come into play when evaluating whether the AMT will apply or not, but there are several common warning signs to watch for under the old and new rules.

Substantial income. High income can cause the AMT exemption to be partially or completely phased out. The TCJA significantly increases the exemptions and thresholds for 2018 through 2025, reducing or eliminating the AMT hit for most taxpayers.

Large itemized deductions for state and local income and property taxes. Under the prior law, these taxes can be fully deducted for regular federal income tax purposes, but they’re completely disallowed under the AMT rules. Under the TCJA, the regular tax deduction for state and local income and property taxes is limited to $10,000. So, this risk factor has lost most of its teeth.

Multiple personal and dependent exemption deductions. Under the prior law, these deductions are disallowed under the AMT rules. Under the new law, personal and dependent exemption deductions are eliminated. So, this risk factor is gone under the TCJA.

Exercise of “in-the-money” incentive stock options (ISOs). The so-called bargain element (the difference between the market value of the shares on the exercise date and the exercise price) doesn’t count as income under the regular tax rules, but it does count as income under the AMT rules. Unfortunately, this risk factor still exists under the new law.

Significant miscellaneous itemized deductions. Examples of these deductions include investment expenses, fees for tax advice and unreimbursed employee business expenses. Under the prior law, you can write off these deductions for regular tax purposes, but they are disallowed under the AMT rules. Under the TCJA, most miscellaneous itemized deductions are eliminated. So, this risk factor is basically gone.

Interest from “private activity bonds.” This income is tax-free for regular federal tax purposes, but it’s taxable under the AMT rules. Unfortunately, this risk factor still exists under the new law.

Significant depreciation write-offs. Individuals may deduct depreciation expense for fixed assets — such as machinery, equipment, computers, furniture and fixtures — from owning sole proprietorships or investing in S corporations, limited liability companies or partnerships. These assets must be depreciated over longer periods under the AMT rules, which increases the likelihood that you’ll owe the AMT.

Under the new law — for assets placed in service between September 28, 2017, and December 31, 2022 — businesses can deduct the entire cost of many depreciable assets in the first year under both the regular tax rules and the AMT rules. So this risk factor is diminished for newly added assets. However, it continues to exist for older assets that are subject to the depreciation schedules allowed under the prior law.

Contact a Tax Pro

Though the new law reduces the odds that you’ll owe the AMT for 2018 through 2025, don’t automatically assume you’ll be exempt. Be aware of the risk factors that still apply under the new law, because IRS auditors are specifically trained to find them. If you fail to report your AMT obligation, you’ll owe back taxes, interest, and possibly penalties.

Ask your tax advisor about your AMT exposure. If you’re at risk, some planning strategies may be available to lower your AMT profile.

© 2018