One of the most favorable tax provisions for long-term investors is the lower tax rate on capital gains for assets held for longer than a year. If you sell an investment you've owned long enough to qualify for these long-term capital gains rates, you'll pay a maximum of 20% on your gain, and those in the 10% and 15% tax brackets get to enjoy tax-free long-term capital gains.

Yet the recent tax reform proposal from the White House has reminded investors that there's a second system of taxation that can make you pay more to the IRS. The alternative minimum tax, or AMT for short, was designed to ensure that tax breaks don't reduce anyone's tax liability below a certain critical point. Although the AMT does incorporate favorable capital gains rates, there are some other ways in which capital gains can affect what you'll pay in alternative minimum tax.

Tax forms and a pencil on top of a shallow pile of $100 bills.

Image source: Getty Images.

How the AMT generally works

The AMT is in some ways simpler than the regular tax code. In general, the AMT has fewer deductions and other tax breaks, but it gives taxpayers a larger initial exemption. For 2017, single taxpayers can get to treat $54,300 of income as exempt from AMT, while joint filers get an $84,500 exemption. In exchange, you can't take deductions like state and local income and property taxes, interest on home equity loans, and the standard deduction.

Under current law, the AMT has two tax rates. Your initial income is subject to tax at 26%. Above a certain threshold -- $187,800 for 2017 for most taxpayers -- a higher 28% rate applies.

How capital gains get treated under the AMT

Although the AMT has a simpler rate structure, it still incorporates some of the complexity of the regular tax code. Specifically with capital gains, the lower tax rates on long-term gains still apply. Under a worksheet in which you calculate your AMT liability, you'll go through several calculations that effectively determine how much of your long-term capital gains are subject to tax at which rate. The result is that your long-term capital gains don't directly result in a change to your AMT liability.

Another provision of the AMT, however, does get affected by capital gains, and that can lead to an indirect boost to your total taxes. The key involves a provision under which the exemption from AMT discussed above gets phased out above certain income levels. In particular, for single filers with AMT-eligible taxable income above $120,700 or joint filers above $160,900, you start losing your AMT exemption. The exemption goes away at a rate of $0.25 for every $1 above the threshold.

Capital gains income does get taxed at a lower rate, but it still counts toward taxable income, and if it kicks you over the threshold, it can lead to your losing a portion of your exemption.

An example

To see how this works, let's say that you have AMT taxable income of $200,000. You're trying to decide whether to take a $1,000 long-term capital gain.

Under the regular tax system, someone with AMT taxable income of $200,000 would typically pay a 15% tax rate on the long-term capital gain. That would result in an additional $150 in tax.

With the AMT, you have to consider the impact of the reduction in the exemption. On top of the $150 in capital gains tax, the $1,000 of capital gains income would reduce your exemption by $250. You'd end up paying AMT on that $250. At a 28% rate, that would incur additional tax of $70. Combined, that's $220 in extra tax, or a 22% combined effective rate because of the capital gain.

Be careful with the AMT

The AMT is most likely to capture people who have incomes in the $200,000 to $400,000 range. Below that amount, most taxpayers are able to use the AMT exemption to shield their income from further tax. Above the top end of the range, the higher 35% and 39.6% tax rates impose additional tax above the 28% top rate for the AMT, making it less likely that alternative minimum amounts will actually be higher than the regular tax due.

If you're stuck in the middle, you can't afford to ignore the AMT. In some cases, even low-rate long-term capital gains income can lead to surprising consequences that will cause you to pay more than you expect to the IRS.

The Motley Fool has a disclosure policy.