Tax Reform Blunts the Bite of the AMT
Taxpayers, including high-income retirees, who've been snared by the AMT before have a better chance of being spared in 2018 and beyond.
Tax reform didn't quite streamline the regular tax system to the point that taxpayers could file their returns on postcards. But the new law does simplify the parallel tax system known as the alternative minimum tax. Even better, the changes mean far fewer people are likely to get snared by the AMT. Only 200,000 taxpayers are estimated to owe the tax in 2018, compared with about 5 million taxpayers if the new law hadn’t been enacted. “Its teeth have been taken out,” says Gil Charney, director of the Tax Institute at H&R Block.
For high-income taxpayers, tax season generally means figuring taxable income twice: Once under the regular system and once under the AMT. Figuring AMT income is “mostly deleting deductions for regular tax purposes,” says Mark Luscombe, principal federal tax analyst for Wolters Kluwer Tax & Accounting. Because of all the items added back, it’s often difficult for well-off taxpayers to wrangle themselves out of the AMT.
With tax reform, “the mechanics of the AMT haven’t changed at all,” says Charney. Take taxable income, add back some write-offs and then apply the AMT exemption. If your AMT taxable income is higher than your regular taxable income, you’ll owe extra tax.
But the new tax law pummels the AMT with a one-two punch. Changes to the regular tax system reduce the chances of getting caught by AMT, and hefty increases to the AMT exemption amount and the range where that exemption phases out will spare many taxpayers from the alternative system altogether.
“The exemption itself is higher, but the range of when that exemption phases out is much higher,” Charney says. The exemption for AMT climbs from $54,300 to $70,300 for single filers and from $84,500 to $109,400 for joint filers. And the exemption starts phasing out at $500,000 for single filers, up from $120,700 previously, and at $1 million for joint filers, up from $160,900 under the old law.
The higher exemption and phaseout amounts are likely to save a large swath of taxpayers from AMT, particularly those in the income range of $200,000 to $500,000. “It’s like the tide coming in; it covers a lot of the beach,” says Charney. The changes are in effect through 2025; after that, unless Congress acts, the rules will revert back to those in effect in 2017.
The law keeps AMT tax rates at 26% and 28%. But because tax rates in the regular system have dropped, the rate difference narrows between the two systems.
An indicator of the IRS’s expectations of the impact of changes affecting the AMT: The agency plans to retire its AMT Assistant online tool after this tax filing season.
AMT, Regular Tax System Falling in Line
Tax reform implemented a number of changes to deductions in the regular tax system, and those changes cause the two systems to more closely track each other. Many of the deductions that used to get nixed when calculating the AMT have now been eliminated or severely restricted in the regular tax system. And that means fewer addbacks for the AMT, notes Eric Meermann, a certified financial planner and vice president at Palisades Hudson Financial Group, in its Stamford, Conn., office. You can’t add back something that’s no longer deductible.
Take state and local tax (SALT) deductions. Tax reform limits state and local income, sales and property tax write-offs to $10,000, whereas previously there was no cap. Adding back just $10,000 to AMT taxable income will have less of an effect than adding back a higher amount, such as $40,000. Adding back that higher SALT amount often snared taxpayers in the AMT in states, such as New Jersey and New York, that have high state and local income and property taxes. The new SALT cap “reduces the possible difference between the two systems,” says Luscombe.
Then there are those write-offs that got completely wiped away in the regular system that used to go away only under AMT. In the regular system, you can no longer write off miscellaneous itemized deductions and interest on home equity debt (unless used to improve a home). And the personal exemption was erased. Because those items are no longer allowed in the regular system, they are no longer addbacks for the AMT. “There is much less to be caught by AMT than under the old law,” Luscombe says.
Another change that further aligns the two: Tax reform equalizes the medical expense deduction threshold in both systems. Previously, for the AMT, only medical expenses exceeding 10% of adjusted gross income could be included as a write-off, while the regular system’s threshold was 7.5%. Briefly, both systems had a threshold of 10%, but tax reform lowered the medical deduction threshold to 7.5% of AGI for 2017 and 2018—and called for that to apply to both systems. “Now for the first time, it’s also 7.5% for AMT,” says Luscombe. When the threshold climbs back to 10% in 2019, it will rise in tandem for both systems, he notes.
Taxpayers who’ve been snared by the AMT before may want to start projecting their tax bill for 2018. There’s a good chance you may find yourself free and clear of the alternative system. Besides knowing you are spared from that extra tax bill, you’ll want to start looking for tax moves to trim your 2018 bill in the regular system.