The AMT remains in-force following the Tax Cuts and Jobs Act (TCJA), but it will impact far fewer taxpayers beginning this year. This is welcome news for many households that are concerned about the $10,000 cap on state and local tax deductions.
The alternative minimum tax was enacted in 1969 as a parallel tax system to ensure a small group of high income earners paid some federal tax. The idea was to disallow certain types of tax-free income that millionaires were privy too. However, by last year, approximately five million households were affected – many of them had annual incomes between $200,000 and $500,000. Following the TCJA, the Tax Policy Center estimates only 200,000 households will pay AMT beginning this year and the expected revenue the AMT generates will decrease by roughly 800%.
There are a few reasons why the drop-off in AMT taxpayers is so significant.
- The TCJA increased the AMT income exemption, which is the amount a taxpayer is allowed to deduct from alternative minimum taxable income (AMTI) before calculating the liability.
- The AMT exemption phase-out level, where you begin to lose the income exemption, was increased significantly. In 2017, the levels were set at $160,900 for joint filers and $120,700 for individuals. For 2018, these thresholds are significantly raised to $1,000,000 for joint filers and $500,000 for individuals. This dramatic increase will allow households earning $200,000 to $1,000,000 to fully use the AMT exemption whereas in prior years they would have surpassed the phase-out level.
- Fewer households will itemize deductions beginning this year so there are fewer items to “add-back” that would otherwise trigger the AMT. The standard deduction has been raised to $12,000 per person and the TCJA limits the deduction for state and local taxes (SALT) to $10,000. Under the prior tax law, filers would receive a deduction for all SALT expenses on their federal return, but those deductions were disallowed under the AMT. Other popular AMT add-backs were personal exemptions and miscellaneous itemized deductions such as investment expenses, fees to accountants, and unreimbursed employee business expenses. Personal exemptions were eliminated under the TCJA as were the miscellaneous itemized deductions that were disallowed under the prior version of the AMT.
So who will remain in the AMT? It is difficult to say as there are a number of factors that could generate AMT liability. Households with very high income could remain in the AMT, but with diminished odds compared to prior years. Individuals that collect interest from private activity municipal bonds or exercise incentive stock options (ISOs) may find themselves paying AMT. The bargain element, which is the difference between the option exercise price and the current market value, counts as income under the AMT rules and will likely be the most common add-back item going forward.
The new AMT rules and reduction in reach are welcome changes, but they come at the expense of some popular tax breaks. The bad news is the TCJA came up short on eliminating the AMT so it will be lurking in the background until these laws expire following 2025.