This Dreaded Tax Is Almost Gone in 2019

It's almost time to get started with your 2018 tax return, and many people are hoping that tax reform will result in their getting bigger refunds once they've filed with the IRS. This'll be the first year that the new tax laws take effect, and taxpayers are paying a lot more attention than usual to see just how different things are than they were this time last year.

For those at the upper end of the income scale, one huge change could mean the near-elimination of one of the most hated taxes they had to pay. Thanks to the modifications that tax reform made to the alternative minimum tax, fewer people will end up getting snared by this additional levy -- even if they might have to do some extra calculations to ensure that they don't have to pay it. Below, we'll provide more details on the dreaded AMT and why so many people will no longer have to worry about it.

Image source: Getty Images.

A brief history of the alternative minimum tax

The AMT has been around in various forms for decades, and until tax reform made its latest changes, the current system had been in place for roughly 35 years. In the early 1980s, tax rates were extremely high, but there were also generous provisions to offer credits and deductions that many people used to get around the tax. The AMT was created to ensure that no one would be able to escape all taxation, which was rapidly becoming a problem because of all the tax gimmicks that high-income taxpayers used to shelter income from the IRS.

The alternative minimum tax essentially created a parallel tax system. Its rates were far lower than the regular tax rates at the time, but it provided for far fewer deductions and other tax breaks. Taxpayers had to calculate their taxes both ways and pay whichever amount was higher. Meanwhile, the law creating the AMT specified that the income limits and exemptions from taxes didn't automatically adjust higher every year to account for inflation. That resulted in more and more people having to pay the AMT as years went by.

More recently, lawmakers started using annual boosts to AMT exemption amounts to prevent alternative minimum tax from hitting even more taxpayers. Those increases were made permanent several years ago, but even with them in place, even some middle-income Americans ended up having to pay the additional tax.

What tax reform did to the AMT

At first, many policymakers wanted to eliminate the AMT entirely -- that's what happened on the corporate side of the tax law. But rather than doing that, lawmakers used a politically savvy approach that kept the law on the books but dramatically reduced its actual impact.

The final law used two changes to accomplish this. First, it raised the exemption amounts under the tax, ensuring that a higher minimum income was necessary before anyone would even have to worry about the tax. You can see the exemption amounts for 2017, 2018, and 2019 below.

Data Source: IRS.

As you can see, the big jumps of $16,000 and $24,900 from 2017 to 2018 dramatically boosted the amount of AMT-free income taxpayers could earn. That prevents the vast majority of taxpayers from having to consider the AMT at all in their tax planning.

Yet for those higher-income taxpayers who'd traditionally paid the AMT in recent years, the more important move was tax reform's provision affecting who got to use those exemptions. The AMT exemption has phaseouts for those making above certain thresholds, and if you make more than the applicable threshold amount, you lose $1 in AMT exemptions for every $4 you make above the specified income level.

Source: IRS.

As you can see, the boost to the thresholds for the 2018 tax year was huge. It largely eliminated one of the main causes for upper-middle-income taxpayers having to pay AMT by getting rid of higher effective marginal rates for alternative minimum tax than for regular tax. Under previous law, income in the phaseout region got taxed for AMT purposes at an effective rate of 32.5% to 35%, which was higher than the 25% to 28% rate that applied under ordinary tax rules. Now the phaseout largely occurs in the 35% and 37% tax brackets for normal income tax purposes -- making it far less likely that the AMT will be greater than the regular income tax for the vast majority of taxpayers.

Is there any chance you'll pay AMT?

Even though the AMT won't be as bad as it was, it's not gone entirely. The AMT imposes tax on certain types of income that are tax-free under normal tax rules, and it also disallows deductions that the regular tax system allows. There are still some taxpayers for whom that state of affairs will remain in place.

But some other changes make that scenario less likely as well. One of the most common reasons for AMT liability came from the fact that the AMT doesn't allow any deduction for state and local taxes. Yet with the regular tax system now limiting those itemized deductions to just $10,000 per year, there's less likelihood of a big difference between the two tax systems, even for the highest-earning taxpayers.

The odds are very good that you'll never have to pay the alternative minimum tax again under the new tax reform rules. It'll take special circumstances for the AMT to snare anyone within its grasp.