It’s bad enough that you might get stuck paying the alternative minimum tax (AMT). That it takes a tedious calculation to know for sure is salt in the wound.
Indeed, IRS Form 6251, which is used to calculate taxable income under the AMT, requires 60 lines of mind-numbing computation using a different set of tax rates, income “addbacks” and rules. Ultimately, the parallel tax system, which was instituted to prevent the wealthy from sheltering too much of their income, eliminates many of the personal and standard deductions available under the ordinary tax system.
Taxpayers who may be subject to the parallel tax must calculate their liability using both the standard method and the AMT and pay whichever is higher.
“It’s very painful as far as filling out the form,” said Melanie Lauridsen, a technical manager on the tax staff for the American Institute of CPAs. “The first time you fall into AMT is a little bit of a shock.”
Generally speaking, taxpayers on either end of the income spectrum are immune from AMT, says Lauridsen.
High-income earners are already subject to the top 39.6 percent tax bracket and are ineligible for many deductions under the regular tax system. Thus, they pay more under their standard tax system than they would under the AMT.
“At the end of the day, the amount of money the super rich pay in taxes ends up higher under the ordinary tax system, so they’re not generally subject to the AMT,” says Lauridsen. “A lot of people think they’re getting away with it because they’re not paying the AMT, but that’s not the case.”
Lower-income taxpayers are also generally exempt.
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It’s the millions of taxpayers that fall somewhere in between who increasingly get ensnared.
Middle-income taxpayers most vulnerable to AMT include those with many children, since personal exemptions disappear, married taxpayers, since the “marriage bonus that applies to regular income tax is disallowed, and those who claim miscellaneous itemized deductions, such as medical or dental expenses. Taxpayers who exercise incentive stock options, realize significant capital gains or live in a high-tax state are also often subject to the AMT, since state and local tax is not deductible under the AMT.
In 2013, for example, a married couple earning $400,000 with two children and $80,000 in itemized deductions, including $20,000 in property taxes and $23,000 in state income taxes, would be subject to AMT of $8,890 on top of their ordinary income tax, according to Mark Luscombe, principal tax analyst for CCH in Riverwoods, Ill. But a taxpayer with property taxes of $5,000 and state and local sales taxes of $5,000 would be exempt from the AMT.
Any taxpayer could be caught by the AMT, but Lauridsen said households earning $75,000 or more that claim at least one of the deductions that are excluded under the AMT should err on the side of caution and fill out the form.
Households earning more than $150,000, regardless of how many exemptions and deductions they claim, should also fill out the form.
If you owed AMT last year, chances are you’ll owe it again, said Luscombe.
If you’ve never paid it before but fear you’ve tipped the scales this year with higher income or a set of triplets, grab a pencil, your 1040 and a double shot of espresso. It’s time to get busy.
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For those who use tax-preparation software or pay a tax professional to file their income-tax returns, the AMT calculation is done automatically on their behalf, whether or not they’re aware it’s happening.
If you file a paper return, you’ll have to do the legwork yourself.
The IRS offers a simple AMT Assistant tool on its website that helps taxpayers determine whether they need to complete Form 6251 at all. The tool offers a series of prompts based on your 1040 return.
You may have to pay the AMT if your taxable income, plus certain adjustments, is more than the AMT exemption amount for your filing status. If your income is below this amount, you usually will not owe AMT, said Rick Norris, a certified public accountant with The LA CPA in Los Angeles.
Norris said taxpayers who calculate the AMT themselves can lessen the pain by using IRS e-file to prepare and file their tax return. E-file software will figure AMT for you if you owe it.
There’s also a worksheet in the instructions for Form 1040 that can help you determine whether you’ll need to complete Form 6251.
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The formula to estimate the amount of AMT you may owe is also fairly straightforward, but you’ll need to use Form 6251 to determine your actual tax liability.
Start with line 41 on your Form 1040, which is your AGI after deducting your standard deduction or itemized deductions but before subtracting your personal exemptions. Add to that your total tax-benefit items, including tax preferences and adjustments, to arrive at your AMT income (or AMTI).
Adjustments include standard and personal exemptions, certain itemized deductions, mortgage interest, taxes, medical expenses and investment interest. Preference items, which get added back into taxable income after the adjustments are made, include tax-exempt interest from municipal bonds, exercise of an incentive stock option, depreciation and percentage depletion/excess intangible drilling costs, according to the IRS.
Next, subtract your AMT exemption amount to determine the amount of your AMTI that is subject to tax at the AMT rates.
For tax year 2013, the maximum AMT exemption amounts are $51,900 for single taxpayers and heads of household, $80,800 for married taxpayers filing jointly and $40,400 for married filing separately. The AMTI exemption phases out above $153,900 for married joint filers, $115,400 for singles and heads of household and $76,950 for married taxpayers who file separately.
After subtracting your exemption amount, multiply the remainder by your AMT rate, which will be either 26 percent or 28 percent. AMTI at or below $179,500 is taxed at 26 percent, while AMTI above that threshold falls into the higher 28 percent.
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The resulting figure is your tentative minimum tax, or TMT. If your regular tax is higher than your TMT, you won’t owe AMT. If your regular tax is lower, the difference between the two taxes is the amount you owe in AMT in addition to your regular tax.
Thus, if your regular income tax is $30,000 and your AMT is $45,000, you must pay $15,000 on top of the $30,000 you owe for ordinary income tax.
There’s no avoiding the AMT if you owe it, but there are ways to minimize the pain of Form 6251.
“It’s complicated to calculate,” said Luscombe, noting that taxpayers who rely on software to file their returns are generally better off. “Start by looking at last year’s return. If you used software, it should be able to show you the AMT calculation and give you some indication as to whether you’re on the bubble this year.”
—By Shelly K. Schwartz, Special to CNBC.com