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%|
|> $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.