Progressive Tax Systems: Marginal Vs. Effective Rates Demystified - Part III

5. Alternative Minimum Tax (AMT) vs. Regular Income Tax

1. Why the AMT Exists

Congress created the alternative minimum tax in 1969 after it was revealed that 155 households with incomes above $200,000 (roughly $1.2 million today) legally paid zero federal income tax, provoking public outrage^[30].

The modern AMT works by forcing filers to recompute their income on a broader base—adding back items such as state-and-local-tax deductions, private-activity-bond interest, certain stock-option gains, and portions of passive-activity losses^[31]. After these adjustments, taxpayers subtract an exemption that is much larger than under the regular code—$88,100 for single filers and $137,000 for joint filers in tax-year 2025^[32]—and then apply a flat 26 percent rate on the first $239,100 of AMT income and 28 percent above that level^[33].

Because of these rules, only about 0.1 percent of taxpayers owed AMT in 2018, generating roughly 0.4 percent of total federal income-tax revenue^[34]. In other words, the AMT is now a narrow back-stop aimed at very high-income returns that aggressively deploy preference items.

2. How the Two Calculations Intersect

Every April, affected filers must complete Form 6251, which walks them through a parallel AMT computation and instructs them to “keep a copy of any AMT versions of forms or worksheets” so future basis, carry-back, and depreciation differences can be tracked^[35]. The regular liability from Form 1040 is then compared with the tentative minimum tax; if the AMT number is higher, the excess becomes an additional tax shown on Schedule 2.

Overpayments are not lost forever: when the AMT arose from timing (deferral) items—such as accelerated depreciation—the extra amount generates a “minimum-tax credit” that can be claimed on Form 8801 to offset regular tax in later years^[36]. The Tax Cuts and Jobs Act temporarily raised AMT exemptions and phase-out thresholds, slashing the number of payers from 5 million in 2017 to roughly 200 thousand in 2018 and holding it near that level through 2025^[37].

Unless Congress acts, those higher thresholds expire on December 31 2025, and the Tax Policy Center projects about 7.6 million households will again fall into AMT in 2026^[38]. Careful year-end planning—especially for incentive-stock-option exercises, large SALT payments, and private-activity-bond interest—remains essential whenever a return straddles the AMT tipping point^[39].

6. How FICA morphs when you work for yourself—and what every paycheck is really hiding

1. Self-employment tax fuels both Social Security and Medicare

Freelancers and other self-employed Americans wear the hat of both “employee” and “employer” in the eyes of the IRS. That dual status is why Schedule SE imposes the full 15.3 percent FICA rate on net earnings: 12.4 percent for Social Security and 2.9 percent for Medicare, mirroring the combined worker-plus-company slice taken from a W-2 paycheck ^[40].

Only the Social Security portion is capped—at $176,100 of earnings for 2025—while the Medicare levy continues without limit and even grows by an extra 0.9 percent once combined wages or self-employment income top $200,000 for single filers (higher for joint returns) ^[41].

Because you are, in effect, paying both halves of the tax, the law lets you deduct the “employer” share (7.65 percent) above-the-line on Form 1040, trimming adjusted gross income. Cash-flow management is critical: the IRS expects quarterly estimated payments that include self-employment tax, not just income tax, and late or underpaid installments trigger penalties. In practice, many solo entrepreneurs open a separate savings account and sweep roughly 30 percent of every client payment into it, ensuring the April 15th bill never becomes a nasty surprise.

2. Why payroll withholding is more than just income tax

Look closely at a U.S. pay stub and you will notice that federal income tax is only one of three major levies quietly siphoning money away before net pay ever reaches your bank. Employees must also part with 6.2 percent Social Security and 1.45 percent Medicare tax, while their employer matches those amounts dollar-for-dollar ^[42].

The combination is known collectively as FICA. Form W-4 tells payroll software how much additional income tax to hold back based on filing status, dependents, and optional extra withholding; miss-estimates often lead to surprise tax bills or large refunds the following spring. State and, in some cities, local income tax withholding piles on top, as do elective pretax deductions like 401(k) deferrals or health-insurance premiums, each of which shrinks taxable wages in its own way.

The result: two employees earning the same gross salary can see hundreds of dollars of monthly difference in take-home pay depending on where they live and the benefits they elect. Understanding these moving pieces allows workers to adjust W-4 entries mid-year, avoid penalties for under-withholding, and deliberately time deductions—such as maxing a 401(k) in high-income months—to keep their marginal tax bracket in check.

References

1. [30] Tax Foundation backgrounder on the AMT
2. [31] Wikipedia: Alternative minimum tax
3. [32] 2025 AMT exemptions
4. [33] AMT rate table
5. [34] AMT share of taxpayers and revenue
6. [35] IRS Instructions for Form 6251, 2024
7. [36] IRS Instructions for Form 8801, 2024
8. [37] Tax Policy Center—How the TCJA changed the AMT
9. [38] TPC projection for 2026 AMT filers
10. [39] IRS Form 6251 guidance on preference items
11. [40] IRS – Self-Employment Tax FAQ
12. [41] IRS – Additional Medicare Tax Q&A
13. [42] IRS Publication 15 (2025) – Employer’s Tax Guide