TCJA – The AMT and Why You May Be Pleasantly Surprised this Tax Season

By: AnnaMarie Mock, CFP®

The changes made to the tax code by the Tax Cuts and Jobs Act (TCJA) of 2017 are now being felt full fledge, and despite early fears, some filers have been pleasantly surprised by their tax returns for 2018. Historically, one of the more loathsome tax rules over the years was the Alternative Minimum Tax (AMT) which disproportionately impacted earners in the Northeast and West Coast where wages and cost of living are higher. In 2018, the rules around AMT have changed increasing the amount of income you must earn to be impacted by the tax.

What is the Alternative Minimum Tax?

AMT was introduced in 1969 and was widely known as the millionaires’ tax because it was designed to ensure that the ultra-wealthy did not get away tax free. In 1969, there were 155 millionaires that paid no tax because of the slew of deductions available to them. In response, Congress passed a bill authorizing the Alternative Minimum Tax to ensure all tax filers paid a minimum amount of taxes. Just 19,000 filers ended up paying the AMT in its first year.

AMT is a required alternative to the regular income tax that is triggered when filers earn more than the income exemption threshold. The AMT uses a separate set of rules where it limits the amount of itemized deductions that can be taken and includes other streams of income not counted by regular income tax. Filers pay the higher of the regular income tax or the AMT calculations, not both.

Congress left out one major detail in 1969 when it passed the bill that authorized AMT. Unlike regular tax brackets that have their exemptions and standard deductions automatically adjusted annually for inflation, the AMT income levels and deductions were not adjusted for inflation. This meant that as income naturally increased due to inflation, more and more people would end up paying the AMT. However, over the years, Congress would pass a “patch” to raise the income threshold, but this was a temporary fix that was not mandated to occur each year. In 2013, Congress passed the American Taxpayer Relief act that automatically adjusted the income thresholds with inflation.

Since 2013, the most notable change to the AMT was done through the TCJA. During the initial negotiations of the tax reform, there was a glimpse of hope that the entire AMT would be repealed. Although it was not abolished, the new AMT rules under TCJA are more taxpayer friendly.

So, what has changed for 2018?

For 2018, there are only two tax rates: 26% on the first $191,000 and 28% on the remaining income. In addition, TCJA raised the exemption and phaseout levels for 2018 tax year until 2025 with automatic cost of living adjustments each year. Below is a comparison of the 2017 and 2018 AMT Exemption and Phaseout rules. The AMT exemption is the amount a taxpayer is allowed to deduct from their income before calculating the AMT tax.For example, if a married couple is filing jointly and has income of $120,000, their taxable income for AMT would be $10,600 which would be subject to the AMT tax rates. The exemption begins to get phased out and reduced by one dollar for every four dollars of income above the phaseout level. For example, if a married couple filing jointly has income of $1,015,000 in 2018, their AMT exemption gets reduced from $109,400 to $105,650 ($1,015,000 - $1,000,000 x 25%= $3,750 reduction in exemption).

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The question everyone is asking is ‘who’s affected by the new AMT rules’? It is anticipated that AMT will affect only 200,000 tax filers this year instead of the 5 million affected in 2017! There are a couple reasons why the number of filers affected will drop significantly:

1) Increased exemption and phaseout limits:
AMT is only triggered if income exceeds the exemption amount, and the AMT tax is greater than the regular tax. With the higher exemption amounts, less income will be used for the AMT determination. Also, less filers will have the exemption amount phased out, allowing for the maximum exemption available.

2) Elimination of certain deductions and lower tax brackets:
Four out of the seven new tax brackets are below the AMT tax rates of 26% and 28%, which reduces the odds of owing through AMT. Also, with the elimination of many deductions from the regular tax code, there will be less income added back into the calculation for AMT purposes.

The new AMT rules can provide for some much need tax relief to those whom historically have been affected but were never meant to be affected. Although fewer people will be affected by AMT going forward, there are still some AMT risk factors that may apply. To avoid any unwanted tax surprises or penalties, complete the IRS form 6251 to calculate the AMT obligation if any.

If you have any questions regarding AMT, please do not hesitate to reach out to the Highland team.