Surprise! You might have to file more than just your 1040. Image: John Morgan via Flickr.
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Most taxpayers find preparing their regular tax return bad enough on its own. But thanks to the law governing the Alternative Minimum Tax, many taxpayers must essentially complete two tax returns -- with the added burden of filing IRS Form 6251 to calculate an additional amount on top of their regular income tax. Let's look more closely at the AMT and why Form 6251 can create a much larger tax bill for you to pay.
Form 6251: Tax prep, part 2
Lawmakers created the AMT to make sure rich taxpayers weren't able to take advantage of tax breaks to avoid paying anything at all. Over time, though, the AMT's original purpose has largely been lost, and the Alternative Minimum Tax now affects many upper-middle class taxpayers while leaving much of the richest part of the population unaffected.
Form 6251 is designed to tell you whether you owe Alternative Minimum Tax. It reflects a completely separate way of thinking about taxation, taking starting figures from your regular tax return but then making you add back potentially dozens of different amounts that the ordinary tax laws let you avoid or deduct. Many lines on Form 6251 are for rare tax breaks that few people take, but those that apply to the most people are the requirement to add back state and local income, sales, and property taxes to your overall income.
Further down the form, you'll see that a whole different set of AMT exemptions apply that don't resemble standard deductions and personal exemptions at all. Moreover, the AMT charges different tax rates than the ordinary income tax, with just two brackets of 26% for lower levels of income up to $185,500 in 2015 and 28% for higher levels of income. The phaseout of exemption amounts further adding to the complexity involved. Yet at the same time, preferential treatment of qualified dividends and long-term capital gains persists under the AMT framework, making it necessary to employ the entire back side of Form 6251 to help calculate total AMT liability.
The final result of completing the AMT form is that by comparing your AMT liability to your regular tax liability, you can determine how much in Alternative Minimum Tax you have to pay. According to estimates, the average payment for those who owe this tax is about $2,000, but in the worst-case scenario you can owe several times that amount.
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What can you do to avoid AMT?
There's only so much you can do to stay out of the Alternative Minimum Tax system. Those who earn between $200,000 and $500,000 are most likely to have to pay. Below $200,000, AMT exemptions prevent most taxpayers from owing additional tax. Above $500,000, higher ordinary tax rates generally push ordinary tax due above the AMT amount.
Because state and local taxes are the primary culprit, most AMT-reducing strategies involve controlling those taxes. Moving to a state with less onerous taxes is one option, albeit one not available to many taxpayers. Alternatively, doing your best to spread out taxes rather than bunching them into a single year can sometimes make it possible to avoid the AMT.
Also, certain stock options your employer might offer can create AMT liability when you exercise them. Timing can therefore be critical, particularly because you can also become eligible for a future AMT credit under certain circumstances involving stock option exercises.
Finally, be sure to take advantage of deductions that qualify for favorable treatment under both the regular and AMT schemes. 401(k) contributions and donations to charity are a couple ways to reduce the amount of AMT you owe.
The only thing worse than having to go to the trouble of preparing Form 6251 is having to pay more money out of your pocket to cover Alternative Minimum Tax liability. By being aware of the form and its implications before you prepare your taxes, you can do what you can to plan and minimize how much in AMT you'll owe.
The article IRS Form 6251 and the Alternative Minimum Tax: What You Should Know originally appeared on Fool.com.
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