The Alternative Minimum Tax (AMT) was originally established to target the wealthiest of taxpayers and was called the “Millionaire’s Tax.” Established in 1969 (as the Tax Reform Act) and put into operation in 1970, it was initially created to target 155 high-income households that took advantage of so many tax benefits available that they owed little to no federal income taxes. However, through the coming years, the Alternative Minimum Tax began to target income tax brackets were not adjusted to accommodate the effects of inflation. Thus more and more middle-income households began to fall into this category of income tax payers.
The Alternative Minimum Tax operates in parallel with the traditional income tax system. A taxpayer subject to the Alternative Minimum Tax must compute their taxable income under both systems, and then they are taxed based on the higher of the two.
Currently, the taxpayer must have a taxable annual income of at least $175,000 ($87,500 if married filing separately) to be assessed under the Alternative Minimum Tax system, rather than the regular income tax.
The Alternative Minimum Tax system has been overhauled since its inception, with the most significant changes taking place in 1982 with the implementation of the Tax Equity & Physical Responsibility Act. With this modification the following changes were made:
- Unlike the regular income tax system, under the Alternative Minimum Tax system, no tax deductions are allowed for personal exemptions, nor is the standard deduction allowed.
- State, Local & Foreign income taxes are no longer tax-deductible. However, if you use your home for business, that portion can be deducted from these taxes.
- The interest on home equity loans (HEL) is no longer tax-deductible unless used for home improvements.
Another difference between the regular income tax System and the Alternative Minimum Tax system is that medical expenses may be itemized and deducted ― provided they exceed 10% of your adjusted gross income (AGI) under the Alternative Minimum Tax System. The regular income tax system, on the other hand, requires that medical expenses exceed 7.5% of your AGI. If your employer offers a pre-tax medical deduction plan, you may want to sign up for it. It can help to reduce both your AMT liability and your regular income tax liability.
In 2009, to offer some relief to middle-class taxpayers who found themselves subject to the Alternative Minimum Tax, Congress revised the tax exemption as part of the American Recovery and Reinvestment Act (ARRA). This was a temporary income tax stopgap and will need to be readdressed in 2010.