Ahh, everyone's favorite season is upon us: the birds are chirping, the flowers are blooming, and the people are frantically running around, trying to get their paperwork in to Uncle Sam before Tax Day.
Now, if you've ever filed your taxes before, you know that it's quite the adventure- one filled with stacks of papers, hundreds of lines of inputs, and several calculations along the way. You might wonder, "Wow, this can't get any more aggravating, right?" Wrong. What if I told you that after all of the work you put into calculating your taxable income, you actually have to go back and recalculate it again just to see if you owe Uncle Sam extra money.
That's because there's a little thing called Alternative Minimum Tax (AMT), which typically affects those who make more than a certain threshold per year. On your regular tax forms (Form 1040), you come-up with your Taxable Income, which is your income after taking a series of deductions (expenses that you can use to lower your gross taxable income), but if you find yourself making more than that threshold you should fill-out Form 6251, Alternative Minimum Tax. The Alternative Minimum Tax Form is a recalculation of your tax obligation by adding back many of your deductions, designed to stop the wealthy from getting away with not paying taxes.
That sounds like a great idea, right? So where did it come from? Well, back in 1969, Congress noticed that 155 people who made over $200,000 in 1967--AKA the uber-wealthy--paid absolutely nothing in taxes that year. How? They took advantage of various government tax breaks, a real "kick in the shorts" to Uncle Sam. So Uncle Sam, who is not a fan of kicks to the shorts, created a minimum tax to kick those clever sons-of-a-guns in their shorts!
In 1969, the minimum tax was implemented with an Alternative Minimum Tax Exemption of $30,000 for single filers, meaning that if your taxable income was less than $30,000 you would just pay your regular tax obligation; if your taxable income is above $30,000 you would pay the difference (we'll get into greater detail in a bit). In "2017 dollars" (AKA accounting for inflation) that would translate to an exemption of about $220,150.76.
Oh, so that means we don't have to worry about it if we make less than $220,150, right? Also wrong. Congress, in all its infinite wisdom, held the exemption flat at $30,000 from 1969 to 1992, all while the entire population earned more money each year due to inflation. In fact, it was such a disaster that, by 1992, the inflation-adjusted target wealth ($200,000) was $838,297.87. So what did Congress do to catch up with this 419% increase in their target? Raise the exemption $3,750. Yup, just a 12% increase...
Today, that single filer exemption is a grand total of $54,300, only about 25% of what it should be to account for inflation. Why? Well, political motives and opinions aside, the exemption, starting in 1993, had to be raised “manually” each year by Congress. Back in 2012, however, President Obama signed the American Taxpayer Relief Act, which tied the exemption to the rate of inflation nationally. But, when tied to inflation, it will only ignore the lower income population, yet continue to (wrongly) affect the same people.
Now that we know what AMT is (and how the government has dropped the ball for the entirety of its existence) how does it work?
The first step is to do your taxes as normal, deductions and all, in order to get your Taxable Income. As a “pro tip,” if you are earning more than $54,300 you may want to itemize your deductions instead of taking the standard deduction since AMT disallows the entire standard deduction, but allows some itemized deductions (which are just various deductions taken individually, which is a bit more work but is a more accurate picture of your tax profile).
Then, after taking all of that time to compute the Taxable Income, you must add back certain deductions, like your personal exemption, depended exemption, and deductions for local and state taxes to give you your Alternative Minimum Taxable Income (AMTI). From that number, you subtract the AMT Exemption (our trust, yet horrendously low, $54,300), and multiply that number by the appropriate rate for your bracket (either 26% or 28%). That number is your Tentative Minimum Tax (TMT). Why is it called “tentative”? Well that’s because you only pay TMT if it is higher than your tax obligation from the regular method.
Complicated, huh? Well, as I mentioned before, that’s not the only issue with it. The problem that arises with AMT is that, due to the late idea to peg it to inflation, it really affects middle-class taxpayers, particularly those who are married, have children, and live in a state with high taxes. That is because the AMT calculation adds back the dependent exemption (AKA the exemption from supporting someone other than yourself, like your children), the deductions of state and local taxes, and it, unlike pretty much everything else in the tax codes, doesn’t double your exemption when you’re married (married couples only get an exemption of $84,500, about one-and-a-half times the single taxpayer deduction).
Urban-Brookings Tax Policy Center found that married couples are six times more likely to be affected by AMT than single payers. Additionally, those with three or more children are over four times more likely to be affected by AMT than those without children, and those in high tax states are twice as likely to be affected than those in low tax states. Oh, and to add salt to the wounds, remember how AMT was designed to nab the uber-wealthy, the ones making over $200,000 in 1967? Well, those people are, when adjusted for inflation, making over $1.5 million per year. How many of them are affected by AMT? Only 18.2%.
Yeah, it’s that much of a failure. But what do we do?
Well, the short-term, easy fix is to raise the exemption across the board so that it actually covers the people it intended to in the first place. Shocker, I know. This would reduce the burden on the middle-class, since $1.5 million a year is only slightly above the middle-class’ salary range…
The other option, as crazy as it sounds, is to create a better tax system. You know, one that is easier to navigate and affects people fairly, compared to the present system, which only makes life difficult for the people who can’t afford to pay someone who actually understands this mess.
What can you do? Well, besides not marry, not have kids, and move to somewhere with less taxes, you can use tax software instead of filing on your own. Thankfully, modern tax software will fill out your AMT form automatically and compare the two tax obligations to make sure that you are paying the right amount.
With all that free time you’ll have, it wouldn’t hurt to spend it writing a letter to your Congressperson so they can fix this ridiculous mess they made.
(End rant.)
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