Question. I end up having to pay thousands in alternative minimum tax (AMT) each year. What is the AMT, and what can I do to avoid paying it?

A. The AMT should really be called the alternative maximum tax rather than the minimum tax. Tax law requires you to figure your tax using two separate, parallel tax systems—the regular income tax system and the AMT—and then pay whichever one is higher. The so-called alternative minimum tax on line 45 of your 1040 is really just the difference between what you would owe under the regular tax system and what you would owe under the AMT. If the regular tax bill is higher, that line is zero. If the AMT tax bill is higher, then line 45 is the difference between your tax bills under the two systems.

Historically, the law came into place in 1969 due to political outrage that 155 well-to-do taxpayers were not paying their share of the expenses of our nation thanks to their taking advantage of perfectly legal deductions. In 1982, it became the parallel tax system we know today. In many ways, the AMT is a simpler, better tax system than the regular system, with fewer deductions and brackets. However, until 2012, the exemption and brackets under the AMT were not indexed to inflation, although Congress dutifully “patched” it each year for decades. With time and inflation, many households that would not have been subject to the AMT in 1982 have become subject to it, and now 4–5 percent of taxpayers owe more under the AMT system than the regular system. Because most physicians have top 5 percent incomes, many of them are subject to the AMT.

How AMT Works

Having a goal to pay less AMT may be shortsighted. As a general rule, the goal should be to maximize your after-tax income or at least to minimize the total amount of tax paid. For example, the two easiest ways to pay less AMT are to make less money (and thus owe less tax) and to make more money (and thus owe more under the regular tax system than under the AMT). As a general rule, making less than $250,000 or more than $500,000 will keep you from owing AMT, although there are exceptions.

The key to understanding the AMT and decreasing your AMT tax bill lies in understanding which deductions can be used under both systems and which ones can only be used under the regular tax system.

The AMT system has just two brackets. In 2014, taxable income under $182,500 ($91,250 if married filing separately) is taxed at 26 percent, while taxable income above that amount is taxed at 28 percent. The exemption is also simpler. Instead of getting $3,950 for yourself and each dependent, the taxpayer receives an exemption of $52,800 ($82,100 if married filing jointly). However, this exemption is phased out between taxable incomes of $117,300 and $328,500 ($156,500 and $484,900 if married). The effect of this phase-out is to increase your marginal tax rate within the phase-out range from 28 percent to 35 percent. However, there is often a “sweet spot” above this phase-out range, where your marginal tax rate actually decreases from 35 percent back to 28 percent. If you are in this range, you may actually wish to accelerate your income to take advantage of it.

The key to understanding the AMT and decreasing your AMT tax bill lies in understanding which deductions can be used under both systems and which ones can only be used under the regular tax system. For example, when you have another child, you get another $3,950 exemption under the regular tax system but not under the AMT. You also cannot deduct state and local income taxes, property taxes, child care expenses, or interest earned on certain types of municipal bonds. However, charitable contributions, most mortgage interest, and retirement account contributions can be used under both systems.

The following events can cause you to owe more taxes due to the AMT:

• Having another child
• Moving to a high-tax state
• Paying off your mortgage
• Reducing your tax-deferred retirement account contributions
• Taking the standard deduction
• Increasing your income
• Investing in “private activity” municipal bonds
• Decreasing your charitable contributions

If you wish to reduce your tax bill, you simply need to do the opposite and take advantage of deductions valid under both systems by:

• Increasing retirement contributions
• Giving more to charity
• Paying a lot of mortgage interest
• Avoiding “private activity” municipal bonds
• Deferring income to the new year (making less)

Obviously, giving more to charity and paying more interest on your house may not make you wealthier, even if they do lower your tax bill. But if you are going to do these things anyway, you might as well maximize the benefits.

Once you have your tax data plugged into the program, play around with the numbers on the 1040 and Schedule A. See what happens if you make $1,000 more or less. See what happens if you pay your property or state income taxes in December instead of in January.

Tax Planning

If you really want to get serious about tax planning, either find a good tax strategist (most tax preparers won’t take the time to do this) or learn how to do it yourself with inexpensive tax software, such as Intuit’s TurboTax. Once you have your tax data plugged into the program, play around with the numbers on the 1040 and Schedule A. See what happens if you make $1,000 more or less. See what happens if you pay your property or state income taxes in December instead of in January. Charitable deductions can also be bunched or unbunched as needed to minimize the tax. However, if you find you are in the sweet spot, where additional income is only taxed at 28 percent instead of 35 percent, consider accelerating income (perhaps by doing Roth conversions) or deferring deductions (like charitable contributions) to next year. Remember to pay attention to the total tax bill, not just the AMT.

Tax planning can be complicated, but a better understanding of the tax code will enable you to pay every cent you owe to Uncle Sam without leaving a tip. If you find yourself paying the AMT each year, it is worth taking the time to understand why and what you can do about it.

Dr. Dahle is the author of The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing and blogs. He is not a licensed financial adviser, accountant, or attorney and recommends you consult with your own advisers prior to acting on any information you read here.