Tax law has so many interlocking parts that many people scurry to find the nearest professional to prepare their returns come tax time rather than trying to handle it themselves. The capital gains tax and the alternative minimum tax – familiarly known as the AMT – are two such interlocking pieces. Deriving income from significant capital gains can push you into AMT territory.
Don’t panic quite yet if you earn a modest income. The AMT is designed to target higher-income taxpayers, although some middle-income Americans were caught by it in years past.
What Is the Alternative Minimum Tax?
The alternative minimum tax came into being in 1969 when U.S. Treasury Secretary Joseph Barr realized that high-income individuals were snagging so many available tax deductions that they were paying zero, or close to zero, in federal income taxes. The rationale was that these taxpayers had more to spend, and spend it they did – on expenses that would seriously whittle away at their incomes under the tax laws at that time. The government, therefore, passed legislation to provide an alternate way of calculating taxes, effectively without claiming all those deductions. This method evolved into the alternative minimum tax in 1982.
The problem with the AMT was that some middle-income individuals were undeservedly finding themselves ensnared by it, and that was never the intention. So exemptions were put into place allowing taxpayers to subtract a certain amount from their incomes. They would only have to pay the AMT on any portion of their earnings that might exceed these thresholds that are set according to filing status.
As of 2019, the exemptions are:
- $71,700 for single taxpayers
- $111,700 for taxpayers who are married and file joint returns
- $42,250 for married taxpayers who file separate returns
AMT Exemption Phaseouts
A phaseout rule comes into effect if you earn a lot more than the applicable exemption for your filing status. Your exemption begins reducing by $0.25 for each dollar you earn over these phaseout thresholds, which also depend on your filing status. As of 2019, the phaseout exemptions are:
- $510,300 for single taxpayers
- $1,020,600 for married taxpayers who file jointly
- $80,450 for married taxpayers who file separately
You would have to subtract $1 from your exemption if you’re single and earned $510,304 – $0.25 for each of those $4 over the phaseout threshold. You can only subtract the amount of the exemption that’s left.
Calculating the AMT
Calculating the alternative minimum tax is one of the more complicated provisions of the Internal Revenue Code.
First, complete your tax return the good old-fashioned way on Form 1040. Now use IRS Form 6251 to add back to your taxable income certain deductions that you took on your 1040. These add-backs include some itemized deductions, the standard deduction for your filing status and some adjustments to income that you might have taken to arrive at your adjusted gross income, or AGI, which is ultimately the amount of income you’re taxed on.
Subtract your exemption amount from this adjusted income figure. You’d have $1,000 in alternative minimum tax income if you’re single and the balance arrived at after adding back all those deductions is $72,700: $72,700 less the $71,700 exemption for your filing status is $1,000.
Finally, apply the AMT tax rates to this $1,000. Your tax due is either this amount or the tax amount you arrived at on your 1040 tax return, whichever is more.
What Are Long-Term Capital Gains?
The AMT applies to all your income, whether you earn it from a job or self-employment or from selling an asset for more than your AMT adjusted basis in that asset, which is typically what you paid for it plus certain allowable costs of sale.
In the case of inherited assets, your basis is their value as of the date of the decedent’s death. Your basis is whatever the donor paid for the gift plus associated costs of sale if an asset is gifted to you by anyone who’s not deceased.
Capital gains are either short-term or long-term. Short-term gains result from assets you sold after owning them for just one year or less. The long-term rates, which are kinder than the regular tax brackets, apply when you sell assets you’ve owned for one year or longer.
Capital Gains Tax Rates
To further complicate matters, there are several capital gains tax rates.
Short-term gains are taxed according to your regular tax bracket along with all your other income. Long-term gains are taxed at either 0 percent, 15 percent or 20 percent, depending on how much overall income you have. The 15 percent rate doesn’t kick in until incomes of more than $38,601 for single filers or $77,200 if you’re married and filing jointly. The 20 percent rate applies on incomes of $425,801 or more for single filers and $479,001 or more for married filers of joint returns.
The IRS also segregates certain types of assets and tags them with capital gains tax rates all their own. You’ll pay a 28 percent rate if your assets are artwork or collectibles, and a 25 percent capital gains tax on real estate which you depreciated on a previous tax return, which typically means that you claimed it as a rental property.
The Capital Gains Home Sale Exclusion
The IRS offers an exclusion from capital gains tax as well – a significant $250,000 for single taxpayers and $500,000 for married taxpayers as of 2019 – if the asset you sold happened to be your home.
In this case, you can subtract the applicable exclusion from the proceeds of the sale and you would only owe capital gains tax on any balance. But, of course, there are rules, one of which is that you must have actually lived in the house for two of the past five years. The IRS figures that this makes it your primary residence.
Effects of the Tax Cuts and Jobs Act
Many of these rules were tweaked by the Tax Cuts and Jobs Act that went into effect in 2018, and that’s basically a good thing. Long-term capital gains tax rates used to be tied to the regular tax brackets. You wouldn’t have to pay the higher regular tax bracket rates, but the lower capital gains rates – 0 percent, 15 percent and 20 percent – were determined by the tax bracket that your overall income fell into. The new tax law assigned long-term gains with income brackets all their own and indexed them for inflation.
The AMT exemptions were increased from what they were in 2017, so you can now subtract more from your AMT income calculations on Form 6251 before you have to worry about paying the alternative minimum tax on the balance. The phaseout restrictions were increased as well.
The exemptions went up by $17,400 for single filers, by $27,200 for married joint filers and by $13,600 for married taxpayers filing joint returns to arrive at the 2019 figures. The phaseout threshold increases were even more significant. The Tax Foundation estimates that 5 million taxpayers were hit by the AMT in 2017, and that number is expected to drop to about 200,000 in tax years 2018 and later.
But be warned: The new law expires at the end of 2025, so it’s possible that all the old rules can come back at that time if the legislation isn’t renewed in whole or in part.
Capital Gains and the AMT
Capital gains – either long-term or short-term – can push you into AMT territory because AMT calculations begin with your overall income. For example, maybe you earn $70,000 from your regular job in 2019. That’s less than the AMT exemption if you’re single, so it’s no problem. You won’t owe the AMT.
But now let’s say that you sell an asset for an additional $50,000. Your basis in the asset is $30,000. This pushes your income up to $90,000: your $70,000 in earnings and a $20,000 capital gain.
Now you have to do AMT calculations to figure out how much you actually owe the IRS. And you’ll still owe one of the capital gains tax rates on that $20,000, depending on the nature of the asset and how long you owned it. You’ll owe the AMT as well because your income is more than the $71,700 exemption for single filers.
What to Do?
You have a few dodging tactics at your disposal to avoid this kind of tax hit. Obviously, you want to chisel away at your overall income as much as possible so you fall below the current AMT exemption threshold for your filing status. You can “harvest” your capital losses and gains and shift them from one tax year to another – although this might be more of a delaying tactic rather than a final fix in some cases. It can nonetheless come in handy if you expect your other sources of income to drop in future years.
For example, maybe you know you have a capital loss – you’re planning to sell an asset for less than your basis in it. Capital losses can be applied against your capital gains, reducing them, and you can even apply up to $3,000 of a loss to other income. Maybe you’re in AMT territory this year, so you might want to sell that asset now and take the loss to shrink your overall income below the exemption threshold.
This works in reverse as well. You can defer the sale of the asset to next year and dodge the AMT bullet this year if you think you’ll realize a significant capital gain from the sale of that asset. Maybe you anticipate less overall income next year, so that would be a good time to sell. You might also consider an “installment” sale, breaking up the income from the asset into separate payments received from a buyer, spreading the total of the capital gain out over two or more years.
Check with a tax professional before you make any of these moves, however, because their success can depend on your overall financial picture and future investment plans.
- Charles Schwab: AMT Triggers
- Fidelity: Alternative Minimum Tax
- TheStreet: The Alternative Minimum Tax and What to Know for 2019
- Tax Foundation: The Alternative Minimum Tax Still Burdens Taxpayers With Compliance Costs
- Tax Policy Center: How Are Capital Gains Taxed?
- IRS: Topic No. 409 Capital Gains and Losses
- TheStreet: What Is the Long Term Capital Gains Tax on Real Estate in 2019
- Bankrate: What Is the Long-Term Capital Gains Tax?