Can you avoid paying AMT?
As tax season approaches, many people are wondering how they can avoid paying Alternative Minimum Tax (AMT). AMT is a tax system designed to ensure that high-income earners pay their fair share of taxes by limiting certain deductions and credits. However, it can also catch unsuspecting taxpayers in its net, resulting in higher tax bills.
What is AMT?
AMT is a separate tax system that operates alongside the regular income tax. It was originally designed to prevent wealthy taxpayers from using deductions and credits to lower their tax bills to near-zero levels. Essentially, AMT establishes a minimum tax that a taxpayer must pay, regardless of how many deductions or credits they are able to claim under the regular income tax system.
The alternative minimum tax is calculated by adding certain income items back to taxable income and then calculating tax based on a flat tax rate. The tax owed under the AMT system is then compared to the tax owed under the regular income tax system, and the taxpayer must pay the higher of the two amounts.
Who is subject to AMT?
Originally, AMT was designed to target high-income taxpayers. However, the income thresholds that trigger the AMT calculation have not been adjusted for inflation in many years. As a result, more and more middle-income taxpayers are finding themselves subject to AMT.
In general, taxpayers with high incomes, large families, or significant itemized deductions are most likely to be subject to AMT. According to the IRS, roughly five million taxpayers were subject to AMT in 2019.
How can you avoid AMT?
There is no foolproof way to avoid AMT, but there are a few strategies that taxpayers can employ to minimize their exposure:
- Be careful with deductions: Certain deductions, such as state and local income tax deductions and miscellaneous itemized deductions, can trigger AMT. Taxpayers may want to consider limiting these deductions to avoid crossing the AMT threshold.
- Watch your income sources: Certain sources of income, such as capital gains and qualified dividends, can increase your likelihood of being subject to AMT. Taxpayers may want to consider diversifying their income sources to avoid this.
- Plan your charitable giving: Charitable contributions are generally deductible under both the regular income tax system and AMT. However, the deduction is limited under AMT, so taxpayers may want to consider timing their donations to ensure maximum tax benefit.
What should you do if you are subject to AMT?
If you are subject to AMT, there are a few options available to you:
- Prioritize deductions: Because AMT limits certain deductions, taxpayers should focus on maximizing the deductions that are still available to them.
- Contribute to retirement accounts: Contributions to retirement accounts such as 401(k)s and IRAs can reduce taxable income and thus lower your AMT liability.
- Consider professional help: Because AMT is a complex system, taxpayers may want to consider enlisting the help of a tax professional to ensure that they are minimizing their liability.
The Bottom Line
AMT is a complex tax system that can catch unsuspecting taxpayers in its net. While there is no surefire way to avoid AMT, taxpayers can take steps to minimize their exposure. By being mindful of deductions, income sources, and charitable giving, taxpayers can reduce their likelihood of being subject to AMT. If you are already subject to AMT, there are options available to you - but it may be advisable to seek the guidance of a tax professional.