Did you know that you're supposed to calculate your income taxes two different ways? First, you figure your tax liability under the regular tax system, which factors in preferential treatment of some income and allows tax credits for certain types of expenses. Then you calculate your taxes using the rules for the alternative minimum tax (AMT), which eliminates some tax deductions and credits. If the AMT is higher, you will be subject to taxes in addition to your regular income tax. Read on to learn more about reducing your AMT. (To continue reading about taxes, see Tax Tips For The Individual Investor .)
Tutorial. Personal Income Tax Guide
Source: Congressional Budget Office
So, the question then becomes, "Are you a candidate to be hit by the AMT?" Consider that your chances of paying this tax increases, if you:
- Have a large family
- Live in an area with high real estate taxes and/or high state and local income taxes
- Claim significant miscellaneous itemized deductions including investment expenses or un-reimbursed employee business expenses.
- Exercise and hold incentive stock options (ISOs)
- Realize significant long-term capital gains
Exemption Amounts for AMT
For 2010, the exemption amounts are:
- Single: $33,750
- Married filing jointly or qualifying widow: $45,000
- Head of household: $33,750
- Married filing separately: $22,500
As a result, you may have to pay the AMT if your regular taxes, combined with certain adjustments and tax preference items, are more than these amounts.
How to Reduce the AMT
One way to minimize the AMT is to reduce your adjusted gross income (AGI). If you participate in a 401(k), 403(b), SARSEP, 457(b) plan or SIMPLE IRA, consider making the maximum allowable salary deferral contributions to your account to reduce your taxable income for both taxes. If your employer offers a cafeteria plan. look into whether you could reduce your taxable income even further by paying for medical insurance, dental insurance, life and disability insurance, and even dependent care expenses through the plan.
If you are self-employed, claiming your business expenses directly against your self-employment income on
the Schedule C instead of as a miscellaneous itemized deduction on the Schedule A reduces your AGI and also ensures that you won't lose any of these deductions to the AMT. Plus, contributing to a SEP IRA, SIMPLE IRA, Solo 401(k) or other qualified plan also helps minimize the impact of this tax.
Self-employed individuals who claim a home office deduction can also reduce the AMT they end up paying. The home office deduction offsets your net self-employment earnings, which reduces your AGI. And while real estate taxes reported as an itemized deduction aren't allowable when calculating the AMT, claiming the home office deduction moves a portion of those taxes against your self-employment income to where they are unaffected by the AMT.
Do you have a sizable investment portfolio outside of your tax-deferred accounts? If so, consider switching to tax-efficient mutual funds and tax-exempt bonds or bond funds as a way to decrease your AGI.
Don't forget that with the AMT, timing is everything. Try to pay your real estate taxes and your state and local income taxes in years that your income might fall outside the AMT range.
To determine whether you are subject to the AMT, you will need to complete Form 6251. Before working through the numbers, visit the IRS's website. where you can download the current year's Form 6251 along with instructions. While you're there, test drive the IRS's new "AMT Assistant" tool, which will help you determine whether you need to file Form 6251 in the first place.
The Bottom Line
Calculating your AMT, or even determining whether you are in fact subject to it, is a complicated process. This article is just an introduction to the subject matter and cannot give you a complete understanding of AMT and how it may affect your taxes. Therefore, unless you are an expert at tax preparation and have a complete understanding of how the AMT works, it may be in your best interest to have your tax return prepared, or at least reviewed, by an expert tax professional who will be able to determine whether you owe the AMT, are eligible for exemptions and are eligible to claim AMT credits for any year - including previous years.