An Example of What Could Happen if an AMT Patch Isn’t Passed

Update 1/2/13: Mercifully, Congress did indeed pass an AMT patch, and it looks like the patch is permanent this time, so we won’t have to go through this every couple of years. So, this blog post is now a moot point, but makes for an interesting read about what would have happened if we had gone over the “fiscal cliff”.

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Congress will surely pass a “patch” to the alternative minimum tax for 2012 … won’t they? ID-10078737

One would hope so, or a lot of people will get hit with a surprise when they file their tax return.

Here’s an example.

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Setup:

“John and Mary” are a fictional married couple, but their situation is based on a situation one of my clients in real life would face if an AMT patch isn’t passed.

Relevant information:

  • Combined salaries: $77,000
  • They have 1 child
  • They do own a home and make charitable contributions, but they don’t have enough expenses to itemize deductions, so they claim the standard deduction instead.

If an AMT patch is passed, John and Mary won’t owe AMT. If a patch isn’t patched, they WILL owe AMT. (But scroll down to the comment section for a discussion of another option John and Mary may have that would result in them owing more tax but not being subject to AMT.)

Calculation (If AMT Patch is Passed):

  1. $77,000 wages – $11,900 standard deduction – $11,400 personal exemptions ($3,800 x 3)= $53,700 taxable income.
  2. Gross tax owed on $53,700: $7,185
  3. Net tax owed: $6,185 ($7,185 minus $1,000 child tax credit)
  4. Alternative minimum tax calculation: in John and Mary’s case, there are no AMT adjustments to make. Their AMT taxable income (“AMTI”) is their $77,000 gross income minus the $77,000 “patched” AMT exemption (estimated and rounded) = $0 subject to AMT.
  5. AMT doesn’t apply.
  6. John and Mary’s tax owed = $6,185
  7. $6,185 / $77,000 = 8.0%

Calculation (If No AMT Patch):

  1. The first three items above are the same ($7,185 gross tax/$6,185 net tax)
  2. Here’s where the differences kick in. Their AMTI is now $77,000 gross income minus $45,000 “unpatched” AMT exemption = $32,000 AMTI
  3. AMT is essentially a flat tax that imposes a 26% flat rate (or 28% at higher incomes). John and Mary are in the 26% range. $32,000 x .26 = $8,320 gross AMT
  4. $8,320 AMT is $1,135 more than the $7,185 “regular” gross income tax owed, so AMT does apply to John and Mary
  5. Their net tax owed = $7,320 ($8,320 AMT minus $1,000 child tax credit)
  6. $7,320 / $77,000 = 9.5%

So the short version is: John and Mary — a solidly middle class family that doesn’t even itemize deductions — would owe $1,135 more in taxes if Congress doesn’t pass an AMT patch.

According to my calculations, a married couple with income as low as $66,700 would be subject to AMT (just $2 of AMT, but subject to AMT nonetheless).

Image courtesy of www.freedigitalphotos.net.

“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”

9 Responses to “An Example of What Could Happen if an AMT Patch Isn’t Passed”

  1. Anthony December 25, 2012 at 5:52 pm #

    If there is no AMT patch, hopefully John and Mary\’s tax preparer will be smart enough to itemize, even though itemized deductions are less than their standard deduction. Under this scenario they will pay less, and it\’s a perfectly legit way to file.

    • Jason Dinesen December 25, 2012 at 6:16 pm #

      Anthony,

      Yes, that’s another option that people would have to crunch the numbers on, if they find themselves subject to AMT. I left that out of this article to drive home a about who would be an AMT target.

      In John and Mary’s case, which is very similar to a real-life client of mine, they would not be subject to AMT by itemizing, but they would still owe more than if there was a patch – about $400 more, which is better than the $1,100 AMT hit, but not as good as if Congress passes an AMT patch).

      I guess the point is, no patch = a lot of average folks will have a layer of complexity added to their tax situation.

      • Anthony December 25, 2012 at 7:27 pm #

        Yep, if you\’re forced to itemize in order to lower your AMT hit, you\’re almost always going to wind up paying more in taxes than if the AMT didn\’t affect you at all (only exception would be is if your taxable income under regular tax is $0 when itemizing, which I guess is possible in one of these AMT scenarios, but I guess you\’d need a whole lot of exemptions).

        I\’ve actually done about half a dozen amendments for people whose original preparer (or software) had them claiming a standard deduction even though, due to AMT, they were better off taking the lower itemized deductions. If the law doesn\’t change (amazing to be this unsure on December 25), we\’re going to probably see this quite a bit this upcoming tax season.

        During December of 2007 (I think it was 2007), while doing an estimate for someone, I once saw a return of someone getting earned income credit and paying AMT. It was crazy. (Of course AMT was patched that year in one of the late fixes.)

        Actually my own return for myself and my wife might wind up being one of those standard deductions with AMT in 2012. I\’ve actually got a substantial pile of Goodwill donations sitting in the garage awaiting Congress to decide whether I should take them in December or January.

        Thanks for talking about it. I\’m amazed with the little I\’ve heard about this in the news.

        • Jason Dinesen December 25, 2012 at 7:34 pm #

          And thanks to YOU for bringing this into the discussion. It’s just crazy, the things people and preparers have to contemplate due to our “leaders” in Congress. This topic of itemize or not itemize is probably worthy of its own full blog post. I’ll add that to my list. :-)

        • Jason Dinesen December 25, 2012 at 7:37 pm #

          PS – I don’t know why the blog is putting slashes into sentences every time there’s an apostrophe. It’s been doing that in blog posts and comments for awhile now.

        • Anthony December 25, 2012 at 7:39 pm #

          Revising my earlier comment about $0 taxable income, another possible scenario would be with positive taxable income but with long term capital gains taxed at 0%.

          The interaction of AMT and long term capital gains is another sometimes non-intuitive one. LTCGs do get the special rates under AMT, but there\’s some weird interaction that goes on there in some situations (I think having to do with the exemption phaseout, which means we\’re talking here about folks with higher incomes, at least higher incomes once you include the capital gains).

          • Jason Dinesen December 25, 2012 at 7:47 pm #

            Now you’ve got me in the mood to do in-depth research into the intricacies of AMT! (And yes, I am passing the time on this Christmas night doing research into various tax things.)

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