Alternative Minimum Tax (AMT) is meant for catching people who avoid paying taxes claiming extensive tax breaks. The number of people affected by AMT is estimated at 25 million. Under the provisions of AMT, if your income goes above a threshold, then there is a cap on the deductions available to you and you end up paying more taxes.
Look at the following reasons which trigger your AMT liability:
- The exemptions you claim – If you claim more and more tax exemptions for yourself and your spouse as well as your dependents, you are likely to get AMT liability.
- The standard deduction – More than 70 per cent of the Americans prefer to claim the standard deduction rather than to go for itemizing. This deduction can contribute to AMT liability because the standard deduction is not allowed under AMT
- State and local taxes – If you are claiming deductions for state taxes and local taxes, these deductions are not allowed under AMT. So if you reside in a place where the state and local taxes are higher, then it is likely that you will be subject to AMT.
- Interest on second mortgages – AMT does allow a deduction towards interest on mortgages used to buy or a build your home. However if you take loan against your home for any other purpose, such interest is not allowed as a deduction under AMT.
- Medical expenses – AMT does allow for a deduction of medical expenses. However such a deduction is more restrictive than the one under the regular income tax. If you happen to claim a deduction for medical expenses as an itemized deduction, it is likely that part of it or all of it may be disallowed when you calculate your tax with AMT.
- Miscellaneous deductions – Certain deductions are available under normal income tax provisions if the total deductions make up more than two per cent of your adjusted gross income (AGI). These deductions include un-reimbursed expenses from the employer, fees paid towards preparation of your tax return, and expenses relating to investments. If you claim a large amount of deduction in this category, that can lead to trigger your liability to pay AMT.
- Intensive stock options – when you exercise an intensive stock option, you need not report that on your regular income tax return. However, it is bound to trigger your liability to pay AMT. The only solution is you should sell the stock during the same year!
- Long-term capital gains – If you have a large capital gain, it is possible to get stuck with the liability of AMT. This is because a huge capital gain will reduce the AMT exemption amount.
- Exempt interest – Some types of interests which are exempt from income tax may or may not be exempt from the AMT liability. This is because of many complicated rules on interest on bonds. If your investment in bonds is not exempt under the AMT, it may lead to AMT liability for you. Even a lot of mutual funds invest in bonds which are not exempt under the AMT. If you receive interest from such funds, you may attract AMT liability.
- Use of tax shelters – There are still some tax shelters available like investing in specific types of partnerships or limited liability companies involving activities like oil and gas drilling. Under AMT provisions the tax benefits are reduced for these activities. You should always check the AMT consequences before investing in such ventures.
To sum up, you should keep in mind these important causes while making your financial decisions. Neglecting them will end up in paying higher taxes.