The AMT is no longer a problem for many clients

The alternative minimum tax used to plague many clients of financial advisers, but the AMT has lost much of its bite due to tax reform.

“No one’s really paying it this year,” said Jamie Hopkins, director of retirement research and vice president of private client services at Carson Group. “A good proportion were paying it before.”

The alternative minimum tax, enacted in 1969, is a system devised to ensure Americans pay their fair share of tax and don’t shield a large portion of income from taxation. Taxpayers affected by the AMT must run two separate tax returns — a traditional income-tax return and a parallel AMT return — and pay the higher of the two sums.

Roughly 3% of all households were subject to the AMT in 2017, skewing primarily toward wealthy Americans, according to the Urban-Brookings Tax Policy Center. Nearly 62% with incomes between $500,000 and $1 million in 2017 paid the AMT; that was true of 27% of households with $200,000-$500,000 of income and 21% with more than $1 million.

However, the result is shaping up to be much different going forward. The Tax Policy Center estimates that only 0.1% of households filing tax returns for 2018 will pay the AMT.

The distribution of the tax now will skew more heavily toward the wealthiest Americans: 11.5% of households with $1 million-plus in income will pay the tax, compared with 2.2% of those with between $500,000 and $1 million and just 0.4% of those with $200,000-$500,000, according to Tax Policy Center projections.

“One of the primary pain points among middle- and upper-middle-class taxpayers was the AMT,” said Vance Barse, adviser at Manning Wealth Management. “It’s back to being a tax on truly high-income earners.”

That’s largely due to changes written into the new Republican tax law. The law, signed by President Donald J. Trump in December 2017, institutes a higher AMT income exemption as well as a big increase in the threshold at which that exemption phases out.

The AMT uses a separate definition of taxable income, called the Alternative Minimum Taxable Income, taxed at just two marginal rates: 26% and 28%.

In 2017, a married couple filing jointly could exempt $84,500 from the alternative minimum tax; but the tax law increased that exemption to $109,400 — meaning more than $30,000 extra is shielded from tax. Further, in 2017, married couples began losing the value of that exemption when AMT income exceeded $160,900; however, the tax law increased that phase-out threshold to $1 million.

“Realistically, you’re saying people with under $1 million of income filing jointly likely won’t be paying any AMT,” Mr. Hopkins said.

The tax law also eliminated or watered down many popular deductions such as one for state and local taxes. Taxpayers can only deduct up to $10,000 of state and local income taxes, whereas the deduction used to be unlimited.

In the past, large SALT deductions often exposed clients to the alternative minimum tax, advisers said. That’s because taxpayers can’t deduct state and local taxes from their AMT income — meaning big SALT deductions increase the odds of making the AMT larger than traditional income taxes.

“Most clients will no longer suffer an AMT because of the near elimination of the SALT deduction,” said Robert Keebler, founder of Keebler & Associates.

Of course, no longer paying the alternative minimum tax doesn’t necessarily mean a client will have a reduced tax liability overall, advisers said.

And, while clients making more than $1 million have a somewhat greater chance of being subject to the AMT, the reality is “it’s not that big still,” said Timothy Steffen, director of advanced planning in Robert W. Baird & Co.’s private wealth management group.

Those likely to pay the AMT are those exposed to more “unusual events” on a tax return, such as exercising incentive stock options, Mr. Steffen said.

ISOs, for example, are stock options granted by employers that carry specific tax treatment. Consider an employer giving employees the right to buy stock at $10 per share, when the stock is actually trading at $25 per share. That $15-per-share spread is only considered income for the purposes of AMT, but isn’t when it comes to a traditional tax return. That means exercising large incentive stock options could make AMT income much larger than that reported on a traditional income tax form.