By Dr. James M. Dahle, WCI Founder
In 1969, Treasury Secretary Joseph Barr announced that 155 high-income households hadn't paid any taxes at all that year. The obvious public outcry prompted Congress to institute an add-on tax it called the alternative minimum tax (AMT), taking effect the next year. As part of the 1982 tax reforms under President Reagan, it was changed from an add-on tax to an alternative tax system, but the goal of ensuring that high-income individuals and corporations had to pay some taxes remained.
Note that there is no “minimum income tax” at the other end of the income spectrum, which is why there is a large percentage of households that have a $0 federal income tax bill every year (up from the high 40% range to 61% in 2020 due to the pandemic stimulus). While those folks do pay payroll taxes, sales tax, property taxes, and more, anything withheld from paychecks during the year for federal income tax is returned to them as a tax refund. At any rate, the point of the AMT is to ensure that high earners pay a certain amount of money in federal income tax—not that everyone pays something in federal income tax.
Unfortunately, there was a huge flaw in the AMT system as implemented—the exemption amount was never indexed to inflation. As a result, the tax affected more and more Americans each year with some estimating that more than 15% of people who made $75,000-$100,000 had to pay AMT. In 2017, five million Americans paid tax under the alternative minimum tax system instead of the regular federal income tax system. This includes lots of white coat investors. In 2018, the Tax Cuts and Jobs Act (TCJA) largely rectified this issue and in 2018, only 150,000 taxpayers paid under the AMT system. Unfortunately, due to the fact that it was passed through the Senate via the budget reconciliation process, many of the provisions in the TCJA are temporary, and unless Congress makes some changes, we will revert back to the pre-2018 AMT system in 2026.
What Is the Alternative Minimum Tax (AMT)?
The alternative minimum tax was instituted back in 1969 when those 155 American families who earned more than $1 million owed $0 in federal income tax. This was due to the way deductions were established at the time. Congress didn’t think these families were paying their fair share, and instead of changing the tax code for everyone, it decided to institute an entirely new tax structure to bring these families back into the tax-paying fold.
In its most basic form, the AMT is a totally separate way of calculating how much you owe in taxes. The IRS explains on its website:
“The AMT is the excess of the tentative minimum tax over the regular tax. Thus, the AMT is owed only if the tentative minimum tax for the year is greater than the regular tax for that year. The tentative minimum tax is figured separately from the regular tax. In general, compute the tentative minimum tax by:
- Computing taxable income eliminating or reducing certain exclusions and deductions, and taking into account differences with respect to when certain items are used to compute regular taxable income and alternative minimum taxable income (AMTI),
- Subtracting the AMT exemption amount,
- Multiplying the amount computed in (2) by the appropriate AMT tax rates, and
- Subtracting the AMT foreign tax credit.”
To simplify, think of AMT as a flat tax rate of approximately 28%. This is different than the effective and marginal tax rates. Under AMT, there are only two marginal brackets—a 26% bracket and a 28% bracket. For the tax year 2021, the 28% bracket kicks in after $199,900 of income.
When Do You Have to Pay AMT Tax?
The Alternative Tax System (AMT) is a complete tax system, run in parallel to the regular one with which you're probably more familiar. Each year, you technically have to compute your taxes under both systems and then pay whichever is higher. Prior to 2018, it generally hit those with an income between $115,000-$415,000 the hardest, which is a large percentage of docs.
The AMT is actually quite a bit simpler than the regular tax code. There is only one exemption amount—$118,100 married ($75,900 single) for 2022—and only two brackets—26% up to $206,100 for singles and MFJ ($103,050 MFS) and then 28% above that. There are no personal exemptions or standard deductions. Some of the common deductions used in the regular tax system are disallowed under the AMT.
Prior to 2018, the AMT exemption started phasing out at an income of just $120,700 ($160,900 MFJ). However, as part of the TCJA, that exemption phaseout was dramatically increased, and for tax year 2022, it starts phasing out at $539,900 ($1,079,800 MFJ). It phases out relatively slow, you lose 25 cents of exemption for every dollar of additional taxable income. The exemption is completely gone by $843,500 ($1,552,200 MFJ).
The other major change to the AMT with the TCJA was that many of the deductions that were allowed under the regular system but not the AMT were scaled back or eliminated altogether (personal exemptions, state and local tax deductions, and miscellaneous deductions on Schedule A). The net effect was that for a much larger number of people, the calculation under the regular tax system resulted in a higher amount of tax due than the calculation under the AMT. Thus, a lot fewer people paid “AMT tax,” the difference between the amounts due under the two systems.
Who Pays Alternative Minimum Tax?
Prior to 2018 and again starting in 2026 if Congress makes no changes, three groups of people made out poorly under the AMT. The more of these groups you belong to, the more likely you are to have to pay additional tax because of it.
- People who pay high state and local income taxes. Unlike many deductions which are the same (or even better due to the higher marginal rates), state and local income taxes aren't deductible under the AMT. Thus, those who pay them are more likely to have to pay under the AMT system.
- People with lots of kids. “Finally!” say those DINKs. But since there are no personal exemptions for those with 12 kids, their tax burden under AMT is likely to be higher than under the regular system.
- People who live in high cost of living areas. Not only are many high cost of living areas (such as California and New York City) also high state/local tax areas, but they have the unfortunate effect of higher salaries to go with the higher cost of living. The higher salary triggers the AMT.
These deductions/exemptions that were valid under the regular tax system but not under the AMT are called “AMT Preference Items,” and prior to 2018, the most important one was the state and local income tax deduction (62%) followed by the personal exemptions (21%) and the miscellaneous deduction for business expenses (9.5%). With those gone from 2018-2025, the most important preference items are the (now higher) standard deduction, net operating losses, depreciation, and passive losses. So, if you are itemizing due to having a lot of deductible mortgage interest or charitable deductions and if you have no depreciation, passive losses, or business losses, then you are very unlikely to pay under the AMT system. Exercising incentive stock options, realizing a very large capital gain, and investing in “private activity” (conduit) bonds are also good ways to end up paying under AMT.
This chart from the Urban-Brookings Tax Policy Center demonstrates how many people pay or will pay under AMT each year under current law.
Do I Have to Pay Alternative Minimum Tax?
How do you know if you'll have to pay alternative minimum tax? The single best way is to use tax software. It'll compute it automatically. If you need to know before you do your taxes in the spring, then you'll need to estimate your taxes. If you're too cheap to fork out for TurboTax, you can just spend a few hours with Form 6251. Don't forget the 12 pages of instructions.
But for high earners, the Tax Cuts and Jobs Act of 2018 provided good news. The law increased the exemption for those who would have to pay AMT, meaning fewer people would get ensnared by the AMT, and it drastically increased the limits for the exemption's phase-out, meaning more people could remain in the safe harbor of the exemption. But remember, the changes to the AMT are only in effect until 2026.
How to Avoid AMT
If you owe AMT now, there's not a lot you can do about it other than avoiding private activity bonds and being careful about realizing large capital gains and exercising stocks options. Prior to 2018 and beginning again in 2026 under current law, there are a few things you could (will be able to) do:
If you find you're getting hit with the AMT each year and would prefer not to, you need to increase your deductions that actually count under the AMT. The best options are your retirement accounts. Each dollar stuffed into a 401(k), profit-sharing plan, SEP IRA, or defined benefit plan is a dollar off your taxable i
ncome under both systems. To make things better, you get to keep that dollar, at least until you lose (hopefully a tiny) part of it to taxes upon withdrawal a few decades from now.
The worst option is to disown your kids. This doesn't actually affect the amount you owe under AMT, but starting again in 2026, it will increase the amount owed under the regular tax code, so you can pay that instead of AMT. You can also move out of Manhattan or California. This is smoke and mirrors, though, since it will just increase your federal income tax so you won't pay the AMT instead (although the decrease in state and local taxes—not to mention the cost of living—will probably more than make up for it).
If, for some reason, it's municipal bond interest that's pushing you into the AMT, you might want to consider that when trying to determine your most tax-efficient asset allocation for your portfolio. You can also buy a bigger house (or do a money-out refinance) so you're paying more mortgage interest, or you can give more money to charity. These deductions can actually be more valuable for someone paying AMT than someone who isn't. It can also be helpful to stay out of the $150,000-$415,000 income range. Perhaps you should realize a $1 million capital gain all in one year rather than spread it out. Part-time work may also become more attractive to you. But in the end, there isn't a lot you can do about AMT.
What Deductions Are Typically Safe Under the AMT?
- Charitable contributions
- Mortgage interest for your personal residence (note the home equity loan exception below)
- Deductions for your business taken on Schedule C or through your LLC or S Corp
- Retirement plan contributions
What Deductions or Tax-Advantaged Issues Can Commonly Cause a Physician to Be Subject to the AMT?
Under current law:
- Taking the standard deduction
- Exercising incentive stock options
- Large capital gains
- Private activity bonds
- Depreciation
- Passive losses
- Business losses
Starting again in 2026, all of the above plus:
- Property taxes
- State and local taxes
- Mortgage interest for certain home equity loans
- Unreimbursed business expenses deducted on Schedule A
- Professional fees deducted on Schedule A (including legal and investment advisory fees)
What Are Some Ways to Potentially Reduce Exposure to the AMT?
- Claim itemized deductions even if smaller than the standard deduction
- Ask for a larger expense reimbursement account from your employer in exchange for a smaller salary
- Increase contributions to retirement plans offered by your employer
- Use a dependent care reimbursement arrangement through your employer to deduct your childcare expenses rather than claiming these deductions on your tax return
- Consider timing state, local, and property tax payments to bundle them into an every-other-year payment structure (2026 and later)
- Reduce exposure to private activity municipal bonds
- Have your investment advisor bill fees to your IRAs or 401(k) rather than your taxable (non-qualified) account (if you fall under AMT, then you can't deduct investment advisory or other professional fees even if they exceed the 2% threshold) (2026 and later)
- Consider converting traditional IRA funds to Roth IRA funds if you are comfortable with a 28% tax rate.
Good News About the AMT
Everyone in both political parties knows this system sucks and is a huge flaw, and prior to 2018, they constantly discussed fixing it. They were hesitant to do so, however, because it brought in a lot of money (~$100 billion a year, or about 4% of total federal income tax revenue). Fixing it would mean either spending less or raising another tax, which would just piss someone else off. However, they got over it when they passed the TCJA, and there is a good chance that the tax changes in the TCJA will be extended beyond 2025, especially if Republicans are back in power after the 2024 presidential elections.
There is another nice thing about the AMT. The extra amount paid if you're caught by the AMT can be applied as a credit to your regular taxes in future years, although I understand this generally doesn't apply to “exclusion items” like state taxes and exemptions for lots of kids, which I suspect is what caused (and will cause) a lot of doctors to pay AMT.
What do you think? Did you pay AMT prior to 2018? Are you paying it now? Do you expect to pay it again starting in 2026? What have you done to avoid it? Comment below!
[This updated post was originally published in 2012.]
We have gotten hit by the AMT many years. The most annoying thing (I am an economist, my husband is the physician) is that it seems like good financial choices are penalized, like living in a house far below your income level, while things more generally outside of personal control, like state taxes, are pulled out of the calculation.
We have also blown through the AMT a few years where our income took us beyond the AMT. That is truly bittersweet.
On a unrelated note, I really enjoy your blog. It would be nice to see a post addressing the differences between private practices and multispecialty groups.
Under AMT, only money that is used for the original purchase of a home is deductible. The money that is used for something else (i.e. remodeling, buy car, etc.) in a cash out refinance is not deductible. So I am not sure a cash out refinance helps with AMT.
Amt has resulted in a 35% marginal federal rate for me for years. This is because I am in the phaseout range. My capital gains rate and the qualified dividend rate has been higher as well. The amt is the only reason tax increases talks arent pushing me over the edge, because if regular taxes increase like you say, then ill just avoid amt.
Thanks for the great summary. I was entangled for the first time last year so I haven’t figured out how to unentangle, except possibly by following my accountant’s advice to make more money. Next year I may just pull that off, but for this year, I think I will again be an ATM via Uncle Sam’s AMT. If I figure anything out, I’ll let you know.
One of the comments above spurred my interest in finding out more about the ways in which to maximize retirement fund accumulation as an employed doc who is already maxing out 403, 457, a defined contribution plan (bringing all 3 to $50K) and backdoor Roth. HSA is not a possibility. More specifically, are there additional opportunities to fund retirement if one were to incorporate and use consulting income (separate from employment) to fund something like a solo 401K or SEP, etc., or is there a cap on how much a person can contribute to government-recognized retirement plans in any given year?
Good point Alan. Home equity loans can only be deducted under AMT for the amount used to buy, build, or improve the home. Under the regular system, you can deduct the interest on up to $100K used for whatever. Since money is fungible, I bet that’s a little bit of a tricky distinction to enforce.
LowER- I believe $50K is the limit, no matter how many 401Ks, SEP-IRAs, or Solo 401Ks you are eligible for. However, a defined benefit plan is generally above and beyond that $50K. I suppose it’s possible you could put a little more into a SEP-IRA or solo 401K since part of your $50K is a DBP. Don’t take my word on it though. I’ve looked for answers to similar questions and found little definitive information.
Anne- I agree that neither the AMT or the regular tax system are “fair” or that they “reward” appropriately in all situations. It is what it is. What exactly would you like to see with regards to private practice (I assume you mean a solo practice) and a multi-specialty group? I can think of a few things to talk about on that subject, but it seems like what I have in mind would be pretty superficial and maybe not all that useful.
I think a post of solo vs single specialty vs multiple specialty vs Hospital owned vs HMO / corporate owned practices and income potential would be pretty useful.
Physician statistics on ‘salary’ are often grossly misrepresented, on the low side, for many many specialists. I know why (politics, confidentiality, etc) but he numbers in surveys just don’t fit what we see in reality.
I’d be willing to share my income details, very anonymously, in a guest post or better yet, through you, but it would have to strictly enforce no identifying details…
Reliable salary information is very hard to come by, and you can see why. To start with, what incentive does a doctor answering a survey have to give the correct data? As near as I can tell, all incentives are to report a lower amount.
Guest post authorship is easy to hide if you’d like to submit one. I think a lot of the information we’re discussing here can be pretty specialty specific, but that’s no reason we can’t publish it here.
I’d love to see us harness the power of the WCI community with an anonymous salary survey sent to all members. I’d expect this would be way more accurate than MGMA, etc. The survey could include: specialty, subspecialty, practice model, wages, benefits, FTE#, RVU or RVU percentile, state practicing in (or region for big states), number of office staff. This data could help so so many leverage their own negotiating at work. Thanks!
Lots of personal data to manage securely there. I’m not sure the data would be dramatically better than MGMA either. I’m not even sure we could do it cheaper than they do.
Medscape, Doximity, MGMA, talking to residency and forum friends. What you’re worth shouldn’t be too much of a mystery.
The practice type article I thought might be useful would look at the different types of groups and highlight some of the pros and cons of each type when a physician is considering what job to take. My husband and I had a lot of talks around these.
My husband is with a large (over 700 physicians) multispecialty group while my brother in law is with a single specialty privates practice. My husband is paid through a W2 but not salaried and has some benefits compared to my brother-in-law in that there is no non-compete, he had no buy-in, and he doesn’t have to personally be involved with billing, collections, lease negotiations, etc. On the other hand, my brother-in law can lower his taxable income and deduct things like car payments, etc because of the way his practice is structured, has a possibility of passive income through new physicians joining and paying in, and from investments in surgery centers, etc. Teaching hospitals (universities ) may have pension benefits, etc.
I don’t think many physicians understand these considerations.
I don’t think many residents get any of
Well, I’m not a Doctor, but I did go to Afghanistan as a senior DoD advisor. Because I was a federal civilian I had to pay taxes on my danger pay, even though I was doing exactly what the soldiers were doing. On top of paying taxes on my danger pay, the salaries put our household over will into the AMT brackets. Didn’t matter that I still had a mortgage sized education debt, a young daughter and losses on a rental property. I owed 64k in taxes, 8k of it upon filing. Goodbye college 529 for my daughter. So for one year my family pushes into the AMT threshold and they take so much of my money in taxes that I literally made nothing by risking my life in Afghanistan for a year. These are additional sad facts regarding the punishment imposed by an unfair tax system.
what happens to people with over 500K combined income
They are generally paying more under the regular tax system than they would under the AMT system. So no “extra” AMT tax.
Thanks for the post. The AMT is what confuses me the most about my tax return and it seems to be responsible for most of the US taxes I pay as an expat. My experience is that while living in a foreign country where my marginal tax bracket is much higher (55%) than the top US bracket, the AMT affects the tax rate on both my earned and investment income so that I wind up having a substantial US tax bill.
Interesting. I was wondering who was still getting caught by it.
I do my own taxes via TurboTax every year and this year I’m slightly concerned how the AMT bill will shake out. I calculated the maximum amount of ISO I can exercise this year where my AMT shadow tax bill doesn’t exceed my normal tax bill. Hoping my calculations were correct and that I don’t owe anything substantial. The only way I learn is by trial and error and will use this year as a learning experience for the future. I’ll write a blog post if my calculations were completely off so as to help other folks from not making the same mistakes I made.
Like you said, the AMT was originally not intended to affect the average taxpayer, yet here we are with multitudes of folks in corporate receiving their compensation in ISOs and triggering AMT.
I firmly believe the tax code should not be so complicated.
That would be an interesting post. I also hope your calculations are right!
Do you guys know if as a new independent contractor doing telemedicine as a sole proprietor, you should you apply for an EIN? They say you can and it might help in a couple of ways, but doesn’t really matter big picture. Is there a downside to this? It doesn’t look too hard at the IRS online site.
Thanks a lot my friends.
I agree it doesn’t matter. No real downside though. Free and easy.