Legal Definitions - alternative minimum tax

The Alternative Minimum Tax (AMT) is a parallel tax system designed to ensure that certain high-income individuals, estates, trusts, and corporations pay at least a minimum amount of income tax. It operates alongside the regular income tax system. Taxpayers must calculate their tax liability under both the regular rules and the AMT rules, and then pay the higher of the two amounts.

The AMT aims to prevent taxpayers from significantly reducing their tax burden through various deductions, exemptions, and credits that are allowed under the regular tax system but are disallowed or limited under the AMT. Essentially, it acts as a "floor" for tax liability, ensuring that those with substantial income and certain tax preferences still contribute a fair share.

Here are some examples of how the Alternative Minimum Tax might apply:

• Example 1: High-Income Individual with Stock Options and Deductions
  Dr. Anya, a highly paid surgeon, has a substantial income. She also has significant itemized deductions, including a large amount of state and local taxes (SALT), and has exercised some incentive stock options (ISOs), which receive favorable treatment under the regular tax system.

  How it illustrates AMT: Under the regular tax system, Dr. Anya's many deductions and the favorable treatment of her ISOs might bring her taxable income down considerably, resulting in a relatively low regular tax bill. However, when she calculates her tax under the AMT rules, some of her deductions (like the full SALT deduction) are disallowed, and the "bargain element" of her ISOs is added back as income. This recalculation results in a higher AMT liability than her regular tax liability. Therefore, she must pay the higher AMT amount, fulfilling the AMT's purpose of ensuring high-income earners pay a minimum tax despite utilizing various tax benefits.

• Example 2: Business Owner Utilizing Accelerated Depreciation
  Mark owns a manufacturing company and recently invested heavily in new machinery. For regular tax purposes, he took advantage of accelerated depreciation methods, allowing him to deduct a large portion of the equipment's cost upfront, significantly reducing his company's taxable income.

  How it illustrates AMT: While accelerated depreciation is a legitimate deduction under the regular tax system, the AMT system often requires a different, less aggressive depreciation schedule for certain assets. When Mark calculates his company's tax under the AMT, he finds that the depreciation deduction is smaller, leading to a higher taxable income for AMT purposes. This higher AMT income results in a greater tax liability under the AMT than under the regular tax system, meaning his company will pay the AMT to ensure it contributes a minimum amount of tax despite the regular tax benefits.

• Example 3: Real Estate Investor with Significant Deductions
  Sarah is a successful real estate investor who owns multiple rental properties. She claims substantial depreciation deductions and has some passive activity losses from her investments.

  How it illustrates AMT: Under regular tax rules, Sarah's depreciation deductions and passive losses significantly reduce her taxable income. However, the AMT system has different rules for certain deductions and can limit the amount of passive losses that can be used. When Sarah calculates her tax under the AMT, some of her depreciation might be adjusted, and her passive losses might be treated less favorably. This recalculation results in a higher taxable income for AMT purposes, leading to a higher AMT liability compared to her regular tax liability. Consequently, Sarah must pay the higher AMT amount, ensuring she pays a minimum level of tax despite the significant deductions available under the regular tax code for her real estate activities.