2007 Tax Year AMT Brackets

Congress passed another patch for the Alternative Minimum Tax (AMT) late last year. With that, I can finally calculate the AMT marginal tax brackets for the 2007 tax year. If you are not familiar with AMT, please read my previous post, Tax Deduction Denied.

Because of an exemption phase-out rule, people whose incomes are in the middle of the AMT range pay a higher AMT marginal tax rate than people on either the low or the high end. This is relatively unknown. Many people think there are just two brackets in AMT, 26% and 28%. There are actually four brackets. In addition to 26% and 28%, there are also 32.5% and 35% brackets for people who are in the exemption phase-out range. Unfortunately many people who are hit by the AMT also fall in the phase-out range.

For each filing status, three numbers are pertinent for calculating the AMT brackets.

  Married Filing Jointly Single OR Head of Household
AMT exemption amount (E) $66,250 $44,350
AMT exemption phase-out point (P) $150,000 $112,500
28% AMT breakpoint (B) $175,000 $175,000

 

The AMT exemption amount (E) is the number congress has been increasing temporarily every year in the last few years. The other two numbers have not been changed lately. If your income is below E, you are not subject to the AMT. If your AMT Income is between E and P, your AMT marginal tax rate is 26%. The other two milestones, which I call X and Y, are given by the following formula:

X = (B + E + 0.25 * P) / 1.25

Y = 4 * E + P

For AMT Income between P and X, the marginal AMT rate is 32.5%; between X and Y, it’s 35%. Once you go over Y, the AMT rate drops to 28%. If you are curious in how the formula for X and Y are derived, please read this blog post by IndexFundFan.

For 2007, using values for E, B and P in the table above, X comes out to $223,000 for married filing jointly, $197,980 for single or head of household; Y is $415,000 for married filing jointly, $289,900 for single or head of household. Here’s the complete AMT rate table for the 2007 tax year:

Married Filing Jointly Single or Head of Household AMT Income QD and LTCG*
<= $66,250 <= $44,350 0% 5% / 15%
<= $150,000 <= $112,500 26% 15%
<= $223,000 <=$197,980 32.5% 21.5%
<= $415,000 <=$289,900 35% 22%
> $415,000 > $289,900 28% 15%

* QD = Qualified Dividends; LTCG = Long Term Capital Gains

First notice the marriage penalty. If each spouse earns $80,000, a married couple is in the 32.5% bracket. If they were single, they are both in the 26% bracket. That’s a big difference. Throw in the state income tax and Social Security and Medicare tax, the couple’s combined marginal tax bracket can reach nearly 50%. Also notice the significant penalty on qualified dividends and long term capital gains for people in the phase-out zones . Together with state income tax, the marginal tax rate on qualified dividends and long term capital gains can exceed 30%. That’s a lot higher than the 15% number everybody talks about.

What do you do if you are affected by the AMT, or worse yet, if you are in the AMT exemption phase-out zone? Not much unless you are willing to move to a low/no tax state or not have kids. Know what your marginal tax bracket really is. Use an AMT-free tax-exempt money market fund instead of a regular money market fund or savings account. If you are in the phase-out zone, minimize even qualified dividends and long term capital gains.

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Comments

  1. Ted says

    I’m curious if the AMT causes one to actually end up with less money than before they crossed into AMT territory.

    In other words is, could you net more if you made less?

  2. Alex says

    Rgarding AMT-free mutual funds, I like your calculator and it certainly does make sense for some individuals. I saw that Fidelity has two-tiered AMT-free funds.
    The only concern I have is with the fact that AMT-free funds are backed by municipal securities, which are risky in general, but especially now.

  3. Harry Sit says

    Ted,

    I don’t think the income itself will be completely confiscated by the AMT, i.e. having a marginal tax rate of 100% or more at any point. However, if you have to incur extra expense to earn that income, for example daycare or extra car for commuting, you can end up having less money than before you got into AMT.

    Alex,

    I’m not too worried about the municipal money market funds. See my previous post Risks in Money Market Funds.

  4. Manda says

    My husband and I are in the 33% filing jointly tax bracket (living in Wisconsin) and are trying to decide on a money market fund for our savings/emergency money. We are looking at Fidelity and Vanguard. Should we do an AMT Tax Free fund or the Fidelity Municipal Money Market? Would it be better to not pay AMT or have an account that’s state/federal tax exempt? HELP! This all seems so confusing.

  5. ESS says

    Thoughts about my 80% marginal tax rate?

    I’m going crazy because I just calculated my “effective” marginal tax rate on the income I earned in 2007 and my projected income in 2008. Your post may have something to do with this huge affect.

    In ’07 I earned 287k with $100k deductions and exemptions (simply taxes, interest, charitable contributions and standard exemptions for my wife and 3 kids) and paid $44k in taxes including $2k in AMT.

    However, in 2008 I’ll earn $364k with $90k deductions and exemptions (including a loss of $4200 to my deductions and only $5500k in exemptions) but I’ll pay $104k in taxes ($69k in regular income taxes and $35k in additional AMT).

    So, my incremental income is $77k while my incremental taxes are $60k – netting me $17k more for the year.

    So – I think Ted’s post on Aug 17 is a real potential. I intend to incrementally model the tax effect of every $1k of income and then plot it out to see whether you could actually lose money. Nonetheless, having 80% of it go to the government is not a good deal.

    Any other thoughts about what may be happening?

    ESS

  6. Harry Sit says

    ESS – I’d double check on how you are projecting your tax liability in 2008. Maybe the tool you are using assumed the AMT exemption amount (E) won’t be increased and will fall back to its original $45k number for married filing jointly. Congress has to pass a law to temporarily increase that number every year. Even that doesn’t fully explain the huge tax increase you mentioned. I’d think there has to be a calculation error somewhere. Finally when you calculate marginal tax bracket, you have use taxable income, which takes into account the exemptions and deductions.

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