Targeting high-income taxpayers, the alternative minimum tax was enacted to combat only 155 households who were getting away with not paying any tax at all through credits, deductions, and exemptions. By today’s numbers, the AMT covers millions of families and grows each year. In 2008, the AMT grew to 3.9 million (up from 605,000 in 1997) taxpayers, an equivalent of about 4% of all individuals.

The alternative minimum tax adds certain tax-beneficial items back into your adjusted gross income, recalculating your income tax. There’s a specific set of rules assigned to the AMT regarding how to determine taxable income with allowed deductions

If you opt not to use tax software to do your taxes, and prefer manual filing, you’ll basically need to do your taxes twice to determine if you need to pay the AMT. Calculate your taxes with the standard 1040 rules, and again with the AMT rules.

Situational Example:

The easiest way to explain which tax return is right is to say that the IRS will count the higher of the two amounts: either the standard federal tax or the AMT rate.

For instance, you calculate your tax for the current year is $10,000 using the standard 1040 rules. You also determine your alternative minimum tax is only $5,000. Since the AMT is lower than your federal taxes, you are not required to pay any alternative minimum amount.

Conversely, if the above scenario determines that your traditional taxes equate to $10,000 but the AMT rules increase your taxes to $15,000, then you would become subject to the rules of the AMT and be liable for paying the greater amount, $15,000.