Yes, there is two ways to calculate income tax and you have to pay the higher of the two!
One we all know and love and the second is called the Alternative minimum tax (AMT).
A predecessor to the current AMT was the "minimum tax" was enacted by the Tax Reform Act of 1969 and went into effect in 1970. Treasury Secretary Joseph Barr prompted the enactment action with an announcement that 155 high-income households had not paid a dime of federal income taxes. The households had taken advantage of so many tax benefits and deductions that reduced their tax liabilities to zero. Congress responded by creating an add-on tax on high-income households, equal to 10% of the sum of tax preferences in excess of $30,000 plus the taxpayer's regular tax liability.
The present AMT system was enacted in 1982 to replace the minimum tax and limits tax benefits from a variety of deductions. Yes we have Ronald Regan to thank but of course he had created only tw0 tax brackets 15% and the highest was 28%.
Under the AMT, no deduction is allowed for personal exemptions (other than the AMT specific exemption, which is larger than the personal exemption except for high income taxpayers), nor is the standard deduction. The one deduction that is not allowed and gets many of the lower income taxpayers is the State, local (including real estate), and foreign taxes deduction. However, most other itemized deductions apply at least in part.
Other individual adjustments in computing AMT include:
Many AMT adjustments apply to businesses operated by individuals or corporations. These adjustments tend to deferring certain deductions or accelerate recognizing income.
These adjustments include:
The AMT system comes with a completely different set of rates and deduction rules. People pay it only if their AMT tax amount is higher than their traditional taxes. Translation: If you're paying the AMT, you are by definition paying higher taxes.
Under AMT rules, you still start with your gross income, but many of the usual deductions and exemptions are disallowed. Even though some deductions still stand, including those for mortgage-interest and charitable donations, some other key breaks are lost such as state and local income taxes and property taxes; child-tax credits; and home-equity loan interest.
The way the form works is that it starts with Taxable income and then adds back the deductions not allowed and then adds the preference items. Then an exemption is applied. For tax year 2012, the exemptions are $82,100 for married couples filing jointly, $52,800 for single and head of household filers, and $41,050 for married people filing separately. These sound high but for states with high income and real estate taxes the add backs for state and local taxes alone will be more that the expmetion amount. In addition, the exemptions granted under the AMT have not kept pace with inflation -- while the average paycheck has. For instance, in 1982, the exemption for married couples filing jointly was $40,000. Adjusted for inflation, that would be $95,120 today. Thankfully, under the American Taxpayer Relief Act of 2012, the AMT will now be annually indexed to keep pace with inflation.
Taxpayers in the higher income brackets will have the AMT exemption fully phased out completely.
Even though the highest tax rate under the AMT -- 28% -- is lower than that in the regular tax system -- 39.6% -- AMT victims are paying more because they're paying on a greater amount of taxable income. 26% under
Short of moving to a low-tax state like, Texas, there is not a lot you can do to avoid the inequities of the AMT.
One planning note: If a tax payer is in ALT MIN they are in the 26 or 28% tax bracket. One benefit to that is the marginal tax rate is at most 28% (vs 39.6% for the regular tax system). Therefore a taxpayer may want to accelerate income into the current year or defer expenses into next year. A taxpayer should do this to the point where your regular tax is equal to the ALT MIN tax and the marginal rate is back to 39.6%.
Here is a more exhaustive list of preference items if interested.