When you’re self-employed you have lots of ways to save on your income taxes. Sometimes these work so well you end up owing little or no income tax for the year. This can be so even though you have substantial income.
Sounds good, you say? Yes, but there is one possible catch: the alternative minimum tax (AMT).
The bad news is that, if you get caught by the AMT, you could have to pay extra taxes. The good news is that, due to tax reform, far fewer taxpayers are subject to the AMT than in the past years.
What is the AMT?
Since 1969, the U.S. has had two parallel income tax systems: the regular income tax and the alternative minimum tax. The AMT is designed to force all taxpayers to pay a minimum amount of tax. You pay the AMT instead of your regular income tax if it’s more than your regular income tax.
The ATM was originally intended for the wealthy. But over time it applied to more and more people, not just the affluent. But the new tax reform law that went into effect in 2018 has reversed this trend.
How does the ATM work?
First, you figure your income tax liability under the regular tax rules. You then recalculate your income taxes under the AMT rules. These eliminate or reduce certain deductions and other tax preferences. The AMT also has its own tax rates.
If you claim the standard deduction, figuring the AMT is fairly simple. You just subtract the AMT exemption (see below) from your adjusted gross income (AGI). You then apply the AMT tax rates to this amount.
The AMT is more complicated if you’re one of the ten percent of taxpayers who itemize your personal deductions. You must give back certain deductions. The biggest one is the deduction for state and local taxes. You must also give back the deduction for business operating losses. You get to keep other deductions, such as mortgage interest and charitable contributions.
You then subtract the AMT exemption amount and apply the AMT tax rates. There are two AMT tax rates, as shown in this chart:
|26% AMT Tax Rate||28% AMT Tax Rate|
|Single||AMT income up to $95,550||AMT income $95,551 and above|
|Married, filing jointly||AMT income up to $191,100||AMT income $191,101 and above|
The AMT exemption increased by tax reform
You only pay AMT on AMT income over the AMT exemption amount. The tax reform law greatly increased this exemption. This reduces the number of people subject to the AMT. The chart shows the amounts for 2017 through 2019.
|2017 AMT Exemption||2018 AMT Exemption||2019 AMT Exemption|
|Married, filing jointly||$84,500||$109,400||$111,700|
Higher AMT exemption phase-out levels
The AMT exemption phases out for higher income taxpayers. The exemption declines $1 for every $4 in ATM income over the phase-out threshold. Here again, the tax reform law made major changes. As the following chart shows, the phase-out thresholds are much higher for 2018 and later.
|2017 AMT Phase-Out Threshold||2018 AMT Phase-Out Threshold||2019 AMT Phase-Out Threshold|
|Married, filing jointly||$160,900||$1,000,000||$1,020,000|
The increased phase-out thresholds prevent middle-class taxpayers from being subject to the AMT. In 2018, you must have AMT income over $1,436,600 to completely lose your AMT exemption.
Fewer tax breaks due to tax reform law
The tax reform law also eliminated many personal deductions and exemptions. These include the personal exemption deduction and miscellaneous itemized deductions. It also limited the state and local tax deduction to $10,000. These were the most common deductions that triggered the AMT. With them gone, far fewer people are subject to the AMT.
Putting it together
You calculate and report AMT on IRS Form 6651, Alternative Minimum Tax–Individuals. But, if you use tax preparation software, it will automatically do the calculations for you. It will then tell you if you owe AMT.
Let’s see how the new and improved AMT applies to a typical self-employed taxpayer.
Example: Joe is a single self-employed consultant. He earned $150,000 in business income in 2018. He itemizes his personal deductions. He takes a $10,000 deduction for state and local taxes. He also deducts $15,000 in mortgage interest. His taxable income is $89,424. His regular income tax bill is $35,691.
Joe must now calculate whether he owes any AMT. For AMT purposes, Joe must give back his $10,000 state and local tax deduction. His AMT income after applying his $70,300 AMT exemption is $29,124. His AMT tax amount is 26% x $29,124 = $7,572. Since this is less than his regular tax liability, he owes no AMT.
The bottom line
The bottom line is that, as a result of tax reform, far fewer taxpayers will have to pay the AMT than in the past. Only about 200,000 tax filers will owe the AMT in 2018. Without tax reform, as many as 5.25 million would have had to pay it. So you probably don’t need to worry about it.
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MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.