Legal Definitions - alternative minimum tax (AMT)

The Alternative Minimum Tax (AMT) is a separate federal income tax calculation designed to ensure that certain higher-income individuals, estates, and trusts pay at least a minimum amount of tax, regardless of how many deductions or tax credits they might claim under the regular tax system. Essentially, taxpayers calculate their tax liability twice: once under the standard income tax rules and once under the AMT rules. If the AMT calculation results in a higher tax bill, the taxpayer must pay the higher amount. The AMT aims to prevent taxpayers with substantial income from significantly reducing their tax burden through various tax preferences and deductions, ensuring they contribute a "minimum" fair share.

• Example 1: High-Income Professional with Stock Options

  Dr. Anya Sharma is a highly paid executive who received a substantial amount of incentive stock options (ISOs) from her company. When she exercises these options, the "bargain element" (the difference between the market price and her exercise price) is not taxed under regular income tax rules until she sells the shares. However, this bargain element is considered income for AMT purposes.

  This example illustrates the AMT because even though Dr. Sharma's regular tax might be significantly reduced due to the deferral of income from her ISOs, the AMT calculation includes this "phantom income." If her total income, including the ISO bargain element, pushes her into the AMT threshold, she might find her AMT liability is higher than her regular tax, ensuring she pays a minimum amount of tax on her overall economic gain.

• Example 2: Real Estate Investor with Significant Deductions

  Mr. Ben Carter is a successful real estate investor who owns multiple properties. In a particular year, he takes advantage of various depreciation deductions, interest deductions, and other tax-preferred write-offs that significantly reduce his taxable income under the regular tax system.

  This scenario demonstrates the AMT because while Mr. Carter's regular tax liability might be very low due to these deductions, the AMT system treats some of these deductions differently or disallows them entirely. For instance, certain state and local tax deductions, which are allowed under regular tax, are not allowed under AMT. This difference means his income for AMT purposes is higher, potentially leading to a larger AMT liability than his regular tax, thus ensuring he contributes a minimum amount of tax.