What is AMT Depreciation?

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The alternative minimum tax began as a way to stop high-income taxpayers from using deductions and other strategies to wipe out their tax bill. It's literally an alternative tax system that can stick you with a higher tax bill than you'd have paid for regular income tax. You have to recalculate some deductions, such as depreciation, when figuring your AMT.

TL;DR (Too Long; Didn't Read)

If you calculate depreciation as an income tax deduction, you must recalculate it when figuring your AMT. The AMT depreciation calculation methods are often different, so you arrive at a different amount. If, for example, your income tax depreciation is $500 and AMT is only $200, you add the difference back into your income before calculating your alternative minimum tax.

The Birth of AMT

In 1969, the secretary of the treasury told Congress that 155 taxpayers earning more than $200,000 — the equivalent of millionaires today after adjusting for inflation — had paid zero income tax. They'd maximized existing tax deductions and been careful about the ways they earned income, thereby whittling their tax debt down legally.

After fielding a flurry of complaints from outraged taxpayers, Congress created the alternative minimum tax. Under AMT, taxpayers recalculate their income tax with many deductions stripped out. If your income falls under the AMT exemption threshold, nothing changes. If your income is higher and AMT on it is more than your regular income tax total, you pay the added AMT amount.

For years the AMT, unlike tax brackets, didn't adjust for inflation, so it affects many taxpayers who are not at all equivalent to millionaires. Recent tax law changes shift the AMT rules, so it should have much more impact on the wealthy than the middle class going forward. The changes also exempt C corporations from paying AMT.

At What Income Does AMT Start?

One of the important questions about alternative minimum tax is, "At what income does AMT start?" Because Congress eventually indexed AMT for inflation, the exemption amount changes regularly. In 2020, it is:

  • Income of $71,700 or less is exempt if you're a single taxpayer or filing as a head of household.

  • If you're married, filing jointly, or a qualifying widow or widower, the cutoff is $111,700.

  • If married and filing separately, the cutoff is $55,850. 

Income below the exemption amount isn't subject to AMT. If you make above the cutoff, you can exempt some of your income. Above a certain amount — currently $510,300 for single filers — the amount you can exempt starts to shrink.

IRS Form 6251

You calculate alternative minimum tax on IRS Form 6251. At the top of the form, you enter your taxable income from line 11b on your 1040. Then you adjust that amount by various factors. If, for example, you reported a net operating loss deduction on your taxes, you add it back to your taxable income.

Just to complicate things, some entries have to be calculated differently than you do with your regular tax. You can't always transfer the figures over from your 1040 and related schedules.

After making all the AMT adjustments, you subtract the AMT exemption from your alternative taxable income. You calculate the tax on the remaining amount and if it's more than your regular income tax, you pay the extra.

Alternative Minimum Tax Example

For an alternative minimum tax example or two, suppose you run your business as an S corporation. Unlike a C corporation, your company pays no tax; the income passes through to you, and you pay income tax on it, so AMT applies.

  • You report your taxable income on your 1040 as $62,000, and you're a single filer. If you run it through the AMT number-crunching process and end up with $70,000, great. Your income falls under the exempt amount, so you don't have to pay any AMT. 

  • If you adjust your $62,000 income and end up with $75,500, you subtract the $71,700 exemption amount from your income leaving $3,800. As a single filer, you multiply this by 0.28, getting $1,064. You subtract $3,896 from this, which gives you a negative amount, so you don't have any extra tax to pay.

  • If your income after adjustments is $147,000, that leaves you with $75,300 in nonexempt income. You multiply this by 0.28, then subtract $3,896 to end up with $17,188 in tax. If that's, say, $5,100 more than your regular income tax, you add the extra $5,100 to your tax bill.

There are almost two dozen income adjustments listed on Form 6251 including alternative minimum tax depreciation, passive losses, exercise of stock options, mining costs and income from long-term contracts. There's no convenient alternative minimum tax calculator to plug this information into, but if you don't have a lot of adjustments, the process may not be too wearisome.

AMT and Business Structure

The C corporations of America got a great deal under 2018's big tax-cut bill. Up until that point, corporate income was subject to alternative minimum tax, but no more. If your business is a C corporation, AMT is one tax issue you no longer have to worry about.

Other business structures — sole proprietorship, partnership, limited liability company — are set up to pass through the business income to the owners. You report your share of the income as personal income, and it becomes subject to alternative minimum tax. If you claimed depreciation on your 1040, whether it's a business expense or a personal write-off, you have to deal with AMT depreciation.

To make things even more fun, you don't deal with alternative minimum tax depreciation in just one place on Form 6251. There are several separate categories of AMT depreciation.

  • Depreciation related to passive activities has to be accounted for in the passive activities entry, line 2M.

  • Business activities in which you have no amounts at risk are covered on 2N.

  • If you use farm activity as a legal tax shelter, related depreciation is included on line 3.

  • Alternative minimum tax depreciation related to profit or loss from a partnership or S corporation goes on 2N if certain limitations apply. 

  • Depreciation on assets placed in service after 1986 goes on line L.

AMT Depreciation: The Exemptions

The IRS instructions for alternative minimum tax depreciation include several types of depreciation you don't have to recalculate. AMT isn't an issue for these:

  • Residential rental property you placed in service after 1998

  • Nonresidential real estate placed in service after 1998, provided it has a depreciation period of 27.5 years and you use the straight-line method to deduct it

  • Section 1250 property placed in service after 1998 and depreciated with the straight-line method. Section 1250 includes various types of real estate.

  • Other property placed in service after 1998, depreciated with straight-line methods or the 150% declining-balance method

  • Property for which you used the alternative depreciation system (ADS)

  • Property eligible for a special depreciation allowance, provided the depreciable basis is the same for both income tax and AMT depreciation. This includes allowances for disaster-assistance property, recycling property, some biofuel plants, some opportunity zone property and some disaster area recovery-assistance property.  If you don't apply a special allowance and the property was placed in service before 2016, it's not exempt.

  • If you took a Section 179 expense property for some of your business property, that's exempt from AMT. Section 179 allows you to write off the cost of some assets as an expense rather than depreciating them. If you only write off part of the cost, the rest of the depreciation is subject to AMT depreciation adjustment.

  • Property depreciated by any method not measured in years

  • Some Native American reservation property

  • Movies, videotapes or sound recordings

  • Natural gas pipelines placed in service after 2005 

Recalculating Depreciation for AMT

There's more than one method of calculating income tax depreciation, and there's more than one method for alternative minimum tax depreciation. There are three methods for AMT depreciation:

  • Straight-line 40-year depreciation

  • Straight-line depreciation taken over the asset's alternative minimum tax class life. Different property is assigned to different classes for AMT calculations, each with its own time frame.

  • The 150% declining balance method over the class life. If there's a point at which straight-line depreciation gives a larger deduction, you switch to the straight-line approach. 

Which method you should use is spelled out in the IRS instructions. The asset class life is also determined by IRS regulations. You can look it up in IRS Publication 946, which covers depreciation.

Figuring AMT Depreciation

Despite all the classes and depreciation methods, calculating the effect of AMT depreciation for line L of the form is relatively simple. Using the appropriate method for your asset, calculate the alternative minimum tax depreciation. Subtract this from your regular income tax depreciation and enter the result.

For an alternative minimum tax example, assume you've claimed $800 in depreciation on some of your business assets, and the write-off is subject to AMT adjustment. When you run things through the appropriate AMT depreciation method, depreciation is only $450. Report the $350 difference on line L.

If your AMT depreciation turns out to be $900, you follow the same method of subtracting it from your income-tax depreciation. In this case, you'd enter $-100 on line L.

Special Depreciation Cases

Other types of AMT depreciation figured on other lines of Form 6251 get a slightly different treatment. For example, if you have passive activity loss that includes $800 in depreciation, you don't get to write the $800 on AMT. Instead, you reduce your loss by that amount and then recalculate the loss using AMT rules.

If you're invested in a partnership or S corporation but have no money at risk, you report any losses on Line N of Form 6251. You recalculate any related AMT depreciation as part of recomputing the entire loss using AMT rules. You enter the difference between the AMT loss and the income tax amount on line N.

If you have property that you depreciated according to the pre-1987 rules, you report the depreciation on Line 3 after recalculating the amount. This is also where you refigure tax write-offs from farming for the AMT, including any related depreciation.

Reporting the Adjustment

AMT depreciation is only one of the factors your business may have to consider when working out alternative minimum tax. At the end of the number-crunching, though, you have one figure for your total added AMT tax.

Enter the AMT amount on the first line of Schedule 2. If the amount is negative, enter zero. Schedule 2 is for reporting added taxes such as self-employment tax, household employment tax and alternative minimum tax. You take the Schedule 2 total, report it on your 1040 and add the amount to your tax bill.

If you want to know in advance if you should set extra money aside for AMT, take a look at last year's Form 6251. Take the figures, adjust for any changes — did you claim depreciation on some assets for the first time this year? — and see how it adds up. That should give you a rough idea if the AMT's going to bite hard or not at all.

References

About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com