The alternative minimum tax amplifies or expands the amount of your income that can be taxed. It adds items that were previously tax-free under the regular tax system, and disallows many of the deductions that were previously allowed. The alternative minimum tax increases income tax by disallowing deductions, exemptions and credits.
In 1963, Congress noticed that a lot of people who had a high income also had a lot of deductions. Because of these deductions, these taxpayers paid a lot less tax than people on a lower income who had fewer deductions. Congress implemented the alternative minimum tax to make the tax system fairer.
The alternative minimum tax is not just for high income tax payers. Many middle-income Americans have to pay alternative minimum tax and have their tax credits limited. Over the next few years, it is expected that more and more people will be paying this tax. Because the alternative minimum tax has not been marked for inflation, more people will be subject to it due to the effect of the extra cost of living adjustments to their wages.
The simplest way to see why you are paying alternative minimum tax, or if you have come close to paying it, is by looking at your last completed 6251 form. By comparing your tentative minimum tax (TMT) to your regular tax, you can see how close you are to paying the new tax. Lines 1 to 26 of the form show the increases to your taxable income for alternative minimum tax purposes. You will have to incorporate various deductions back into your income, such as home equity mortgage interest, employee business expenses and incentive stock options.
You will not owe any alternative minimum tax if your TMT is less than your regular tax, but there are other ways you may still be affected by alternative minimum tax. You may not be receiving all of your tax credits, such as working opportunity or low-income housing credits. Your TMT limits these credits and other business credits, as they cannot reduce the tax you pay below the TMT. By studying lines 1 to 26 of form 6251, you can determine what to do to reduce your TMT and allow more business credits. Any business credit that is not allowed may be carried forward 20 years and carried back two years.
There are some precautions you can take to plan ahead for the alternative minimum tax. By using tax-planning software throughout the year, you can minimize your overall tax liability. Study the 6251 form each time you prepare your tax return and see how close you are to paying alternative minimum tax. Work out how close your TMT is to your regular tax. Also, check last year's tax return for any business credits that are being carried forward; if there are any, this many be due to the TMT tax limit.