The Tax Cuts and Jobs Act of 2017 slashed the number of taxpayers subject to the alternative minimum tax, but when the law expires, the exemption will return to pre-2018 levels—and ensnare many wealthy taxpayers.
“Welcome back AMT,” said Michele Lazzara, managing director at CBIZ Marks Paneth in Purchase, N.Y.
The alternative minimum tax was established in 1969 to ensure that wealthy people would pay sufficient income taxes. “If you have a high-income household, exercise stock options or have large capital gains, you stand a good chance of paying AMT,” Lazzara said. However, there have been worries that as salaries have increased over time, more middle-class taxpayers are getting caught up in paying the tax.
Thomas Pontius, senior financial planner at Kayne Anderson Rudnick in Los Angeles, said three things happened under the 2017 tax law that affected the alternative minimum tax: More money was exempted from the tax for various filers, and the thresholds at which the exemptions phased out also rose. Meanwhile, certain types of deductions—such as state and local tax deductions—that the taxpayer had to add back into their calculation in the past were eliminated under the new law.
Altogether, these changes meant much fewer people ended up paying the tax.
“The Tax Policy Center estimates that the number of AMT taxpayers fell from more than 5 million in 2017 to just 200,000 in 2018,” said Erik Preus, head of investment solutions at Envestnet PMC in Minneapolis. If the provisions of the 2017 law expire, which they will without congressional action, the center estimates that the number of taxpayers affected in 2026 will be roughly 6.7 million, he said.
“Many clients understand they’re getting things like their state and local income tax deduction back [when the Tax Cuts and Jobs Act expires] but then don’t realize this is an AMT add-back,” Pontius said. On the other hand, “with income tax brackets increasing, it’s possible their regular tax calculation is more than the AMT amount and they aren’t affected by the AMT changes.”
One way to reduce tax is to keep adjusted gross income as low as possible. “Deferring income to the following year, if feasible, may be a way to do this,” Lazzara said.
“Taxpayers may be able to reduce their [adjusted gross income] by contributing to retirement plans such as 401(k)s and 403(b)s. If you own your own business, you can open a solo 401(k) and may be able to contribute up to $69,000, depending on your income, with the same additional $7,500 catch-up,” she said. “Maximizing pretax contributions to flexible spending accounts and health savings accounts will also help.”
Wealthy taxpayers who have flexibility in the timing of their income might want to accelerate it so they can avoid paying the alternative minimum tax on income they earn before the tax comes back.