High income households can strategically plan their income tax payments to better limit their Alternative Minimum Tax (AMT) liability exposure.
The AMT structure differs from the regular tax system in that it subtracts fewer deductions and instead deducts one significantly larger exemption. This exemption phases out once a threshold is reached and as income increases. The AMT applies a tax rate of 26% on the first $175,000 of income and 28% thereafter.
Households pay the AMT when a great tax liability results when using the regular system; thus, paying the AMT usually results in reduced marginal tax rates.
However, as the AMT exemption phases out, the marginal tax rate increases and approaches a “bump zone” of tax rates. The marginal tax rates jump to 32.5% and 35% until the exemption completely phases out. After this, the marginal tax rate returns to 28%.
Appropriate tax planning allows households to avoid “the bump” of rising marginal rates. Deferring income at the lower end will preserve the exemption taken. If income is higher, accelerating additional income to exit the zone and completely phase out the exemption would return the 28% marginal rate. However, accelerating too much income may subject a taxpayer to the regular 39.6% marginal tax rate instead of the 28% AMT rate. The phaseout threshold depends on the taxpayer’s state income tax rate and how much in excess AMT-adjusted deductions the taxpayer has.
To maximize the AMT exemption and avoid the unwanted “bump,” taxpayers should consult with their tax advisor to discuss anticipated income and deductions in addition to identifying potential areas of liability. Timing can be everything.
— Danielle Haseman, Team Max Elliott Law