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Taxable Income, Tax Brackets, and the AMT Exemption

Todays Date: December 16, 2018

In Part I, we discussed the different tax brackets for the Regular Tax and for the Alternative Minimum Tax, as well as the AMT exemption. For 2009 for married couples filing jointly (MFJ) the AMT exemption was $70,950. In this article we will discuss the phase-out, or loss, of the exemption as taxable income exceeds a certain threshold level. For MFJ, this taxable income threshold is $150,000. The Form 6251 also has the thresholds for the other filing statuses, found at the IRS website.

The AMT exemption phase-out

As taxable income increases above $150,000, the AMT exemption amount decreases. A taxpayer loses $1 of exemption for every $4 increase in taxable income. Thus, for example, if taxable income before exemption is $250,000 ($100,000 over the threshold), $25,000 of the AMT exemption is lost. All other things being equal, in this example AMT taxable income would be $275,000 even though Regular Tax taxable income would be $250,000 – making it likely you would find yourself stuck in the AMT.

Note that this phase-out formula means your AMT taxable income increases at a more rapid rate – 25% faster – than any increase in your Regular Tax taxable income. This acceleration is a significant part of what pulls individuals quickly into the AMT.

Dividends and capital gains

Under current law, dividends and long-term capital gains are taxed at a lower bracket – typically 15% – for both the Regular Tax and for the AMT. In theory, using this same bracket prevents dividends and capital gains from triggering the AMT.

Unfortunately, however, dividends and capital gains are included as part of taxable income, so they, like all other income, have a direct impact on an individual’s AMT because of the extra 25% effect discussed above. It’s easy to be fooled by this one.

Beyond the AMT exemption phase-out

For taxpayers who make “a lot” of money (defined below), the AMT rapidly becomes much less of a concern. There are two forces at work here as income gets into higher levels:

First is that the AMT exemption phase-out simply stops at a certain point. For MFJ, the phase-out stops at taxable income of $433,800. At this point, the $283,800 of income over the initial $150,000 means (at the 4-to-1 ratio described above) the $70,950 exemption is completely gone ($70,950 times 4 equals $283,800). After this, AMT income grows at the same rate as does Regular Tax taxable income, so the 25% penalty no longer applies.

Second is that, at this level of income, the taxpayer now is paying Regular Tax at a significantly higher bracket than the AMT bracket. Looking at the above tax bracket schedules, one can see that the taxpayer now is well into the 35% Regular Tax bracket, leaving far behind the maximum 28% AMT bracket. Remembering that a taxpayer pays the greater of the Alternative Minimum Tax or the Regular Tax, at these levels of income it is unlikely the taxpayer will be in the AMT.

Summary

Once a MFJ couple exceeds the $150,000 taxable income level, the sucking sound of the AMT vortex pulls them in at a rapidly-increasing rate. But for the wealthy – ironically, those at whom the original Minimum Tax was aimed when it was first enacted over 40 years ago – they can safely sit on the sidelines and not even be concerned. This is why, in the tax returns disclosed in the 2008 Presidential campaign, we saw that Joe Biden, John McCain and Sarah Palin – each making in the neighborhood of $250,000 – all were caught in the AMT trap, while President Obama with his millions from book royalties was not even touched by it.

George Bauernfeind is with AMTIndividual, providing analysis, customized strategies, and an online dual tax calculator / planner to help you reduce your Alternative Minimum Tax. Visit www.amtindividual.com or www.amtblog.com to read more tax planning articles or to access this tax software on the Alternative Minimum Tax.

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