This comprehensive guide will provide a deep dive into what AMT is, how it’s calculated, common adjustments, and tax planning strategies to minimize your AMT exposure.
Table of contents
- What is the Alternative Minimum Tax (AMT)?
- AMT Tax Rates
- How is AMT Calculated?
- AMT Adjustments and Preferences
- AMT Carryforward Credits & Form 8801
- AMT and the Tax Cuts and Jobs Act (TCJA) of 2017
- State-Level AMT and Its Implications
- Tax Planning Strategies to Minimize AMT Exposure
- Common Misconceptions about AMT
- Frequently Asked Questions
What is the Alternative Minimum Tax (AMT)?
The Alternative Minimum Tax (AMT) is a federal tax system within the United States designed to ensure that all individuals and corporations pay their fair share of taxes. AMT was introduced in 1969 in response to high-income Americans taking advantage of loopholes in the tax code to bring their taxable income to zero. Over the years, AMT has evolved due to changes in tax laws and inflation, which has led to its application to a broader range of taxpayers.
Who Pays Alternative Minimum Tax?
AMT could apply to you if your regular income tax calculation results in a lower tax liability than the AMT calculation. This can happen if you have certain types of deductions, credits, or income sources, such as equity compensation. It’s important to understand these triggers to make informed decisions about managing your tax liability.
AMT Tax Rates
There are two tax rates associated with AMT: 26 percent and 28 percent. Income below the AMT threshold is subject to the 26 percent tax rate, while income above the threshold is taxed at 28 percent (similar to the progressive federal income tax brackets).
For the 2023 tax year, the AMT threshold is $98,950 for single filers and $197,900 for married couples filing jointly.
How is AMT Calculated?
To calculate AMT, you need to use IRS Form 6251 (Alternative Minumum Tax). Here’s how it generally works:
- Start with your regular taxable income: This is your income after you’ve subtracted your standard or itemized deductions.
- Make AMT adjustments to your taxable income: Certain income and deductions that are treated differently under AMT rules need to be added back or adjusted. For instance, charitable contributions or mortgage interest payments.
- Calculate your Alternative Minimum Taxable Income (AMTI): After making these adjustments, you’ll get your AMTI.
- Subtract your AMT exemption from your AMTI: The exemption amount varies depending on your filing status and income.
If the tax computed through this method is higher than your regular tax, then the difference between the two amounts is the AMT that you will owe.
For example, let’s assume you exercise Incentive Stock Options (ISOs) during the year. Your regular annual income, including both your salary and the profit from the sale of stocks, is $200,000, excluding the spread on the exercised ISOs valued at $50,000. Because of AMT, you would be required to include the $50,000 spread in your income for the year, which will then result in a new AMTI of $250,000, resulting in additional taxes owed.
Now that we’ve outlined the calculation process, let’s look at the adjustments and preferences in the next section.
AMT Adjustments and Preferences
Just as personal income taxes can be adjusted based on deductions, credits, or supplemental income, so can AMT. The list of available AMT adjustments is extensive, and it’s best to work with a Harness Tax Advisor or other tax professional to stay up to date. However, to give you a glimpse of how AMT adjustments can affect your tax computation, we’ve highlighted a few of the most common ones below:
Here are some key AMT adjustments and preferences:
- Tax Shelter Farm Activities: The treatment of capital gains and losses from tax shelter farm activities can significantly differ from the regular tax treatment.
- Charitable Contributions of Certain Property: If you made a charitable contribution of property and had a different basis for AMT purposes, you may need to make an adjustment 1.
- Business Interest Limitation: For AMT purposes, you need to complete an AMT Form 8990 using amounts adjusted for AMT.
- Mortgage Interest: For AMT, you may need to adjust for home mortgage interest deducted for a dwelling that isn’t a principal residence or qualified dwelling.
- Related Adjustments: If you have certain types of income or deductions, such as section 179 expense deduction or self-employed health insurance deduction, you may need to refigure these amounts for AMT.
These are just a few examples of the types of adjustments that might be needed for AMT. The rules are complex, and this list is only a summary. A complete list of AMT adjustments and preferences can be found on the IRS website.
AMT Carryforward Credits & Form 8801
If you’ve paid AMT in a previous year due to certain adjustments or preference items, you might be eligible for the Minimum Tax Credit (MTC) in future years. This credit can offset your regular tax liability, reducing the amount you owe.
The Minimum Ta Credit is essentially a way of recouping some of the AMT you’ve paid in the past. It’s not a refund, but it can lower your future tax bill.
Use the IRS Form 8801 (Credit for Prior Year Minimum Tax—Individuals, Estates, and Trusts) to calculate and claim the Minimum Tax Credit. The form has detailed instructions on how to calculate the credit, including how to account for certain special situations, such as the carryforward of disallowed foreign tax credits.
On Form 8801, you calculate the credit by first figuring out the difference between the tentative minimum tax in the year you’re claiming the credit and the tentative minimum tax in the year you paid the AMT. The result is your minimum tax credit for the current year, which you can carry forward to future years if you don’t use it all in the current year.
Remember that the rules for AMT and MTC are complex, and it may be helpful to consult with a Harness Tax Advisor or other qualified tax professional.
AMT and the Tax Cuts and Jobs Act (TCJA) of 2017
The Tax Cuts and Jobs Act of 2017 brought significant changes to AMT, making it less likely that many taxpayers will have to pay it. Key changes include:
- Increased Exemption Amounts: The TCJA significantly raised the AMT exemption amounts. For the tax year 2023, the exemption amount is $75,900 for single taxpayers and $118,100 for married taxpayers filing jointly.
- Higher Phaseout Thresholds: The points at which the exemption amounts begin to phase out were also dramatically increased. For 2023, these thresholds are $539,900 for single taxpayers and $1,079,800 for married taxpayers filing jointly.
- State and Local Tax Deduction Limit: The TCJA imposed a limit of $10,000 on the deduction for state and local taxes under the regular tax system, which aligns it more closely with the AMT rules and lessens the chance that this item will trigger AMT.
These changes mean that fewer taxpayers will be subject to AMT during the tax years 2018-2025. However, unless Congress takes further action, these provisions will sunset after 2025, and the AMT rules will revert to pre-TCJA levels.
AMT Exemptions and Phase-Out Thresholds
AMTI below the AMT exemption level is not subject to the alternative minimum tax. For the 2023 tax year, the AMT exemption is $75,600 for taxpayers filing as single and $117,200 for married couples filing jointly, per the IRS. The AMT exemption allows you to treat that income as regular income, subject to deductions and credits you might claim. However, anything over the exemption is subject to the alternative minimum tax. After calculating what you owe for AMT, you will pay the higher amount between the AMT income tax and standard income tax.
How AMT Exemptions Affect High Earners
AMT exemptions begin to phase out—reducing by 25 cents for each dollar earned—once a taxpayer’s AMTI surpasses a certain threshold. In 2021, this exemption started phasing out at $578,150 in AMTI for single filers and at $1,156,300 for married taxpayers filing jointly. Depending on an individual’s AMTI, their AMT exemption could be either reduced or eliminated, with the remaining amount subject to the 28 percent AMT.
State-Level AMT and Its Implications
As of 2023, four US states (California, Colorado, Connecticut, and Minnesota) impose a state-level AMT. The rules and rates for state-level AMT, and other state-level taxes, differ from the federal AMT, and the income thresholds and exemption amounts can also vary. Here is an overview of the state-level AMT rules for each of these states:
- California imposes an AMT rate of 7% which applies to taxpayers with specific adjustments and tax preference items. The California AMT exemptions are $91,536 for joint filers, $45,768 for single filers, and $68,652 for head-of-household filers. The exemptions phase out at a 25% rate when AMTI exceeds $197,890 for joint filers, $98,945 for single filers, and $148,417 for head-of-household filers.
- Colorado imposes an AMT rate of 4.63%. It generally follows federal AMT rules and calculation methods, with some adjustments specific to Colorado. Colorado’s AMT exemption amounts and phase-out thresholds are the same as the federal AMT exemption amounts and phase-out thresholds.
- Connecticut imposes an AMT on individuals with certain tax preference items, such as tax-exempt interest from private activity bonds. The AMT rate in Connecticut is 7%. The AMT exemption amounts and phase-out thresholds are the same as the federal AMT exemption amounts and phase-out thresholds.
- Minnesota imposes an AMT rate of 6.75%. It follows federal AMT rules and calculation methods, with some adjustments specific to Minnesota. Minnesota’s AMT exemption amounts are $84,500 for joint filers, $42,250 for single filers, and $63,375 for head-of-household filers. The phase-out thresholds are $207,450 for joint filers, $103,725 for single filers, and $155,587 for head-of-household filers.
State-level tax laws are subject to change and should be carefully monitored every year. If you live in one of these states, it’s essential to be familiar with the state-specific AMT rules, and other state-level tax implications to minimize your overall tax liability.
Tax Planning Strategies to Minimize AMT Exposure
Navigating the rules of AMT requires proactive tax planning, especially for taxpayers with significant preference items like ISOs. Here are some specific strategies you can use to minimize your exposure:
- Spread Out ISO Exercises: If you hold ISOs, you may consider spreading your exercises over multiple years to avoid a large AMT adjustment in a single year. This strategy could help manage your AMTI levels and, in turn, your AMT liability.
- Leverage AMT Credits: If you’ve paid AMT in previous years due to ISO exercises or other preference items, you may have generated AMT credits. These credits are not refundable but can be used to reduce your regular tax in future years when your regular tax is higher than your AMT.
- State Tax Payment Timing: If you’re subject to AMT, your state and local tax payments won’t provide any federal tax benefit. You might consider timing your state tax payments in a year when you’re not subject to AMT.
- Home Mortgage Interest: Since AMT only allows a deduction for mortgage interest on loans used to buy, build, or improve your home, consider this when planning home equity borrowing or refinancing.
- Leverage the AMT Break-Even Workaround: By understanding the intricate interplay between regular tax and AMT systems, you can identify a point where both liabilities are the same, effectively minimizing your tax liability. Harness Wealth’s Equity Tax Insights tool provides an excellent platform for calculating this break-even point for ISO exercise and/or selling equity.
Common Misconceptions about AMT
- AMT no longer applies after the TCJA. While the TCJA made significant changes that reduced the number of taxpayers subject to AMT, it did not eliminate it. High-income taxpayers and those with significant preference items may still be subject to AMT.
- If I paid AMT last year, I will pay it this year too. Not necessarily. Your AMT liability can change from year to year based on your income, deductions, and preference items.
- AMT is double taxation. While AMT may result in a higher tax bill, it’s not double taxation. It’s a parallel system designed to ensure that all taxpayers pay a minimum amount of tax.
Frequently Asked Questions
- How do I know if I need to pay AMT? To determine if you owe AMT, you must calculate your taxes using both the regular tax system and the AMT system. If your AMT liability is higher than your regular tax liability, you will need to pay the difference as AMT.
- Can I get a credit for paying AMT in the past? Yes, you may be eligible for the Minimum Tax Credit (MTC) if you have paid AMT in previous years due to certain deferral items, such as exercising incentive stock options. The MTC can be used to offset your regular tax liability in future years, up to the point where your regular tax equals your AMT liability.
- Does AMT affect my capital gains tax? While long-term capital gains and qualified dividend income are taxed at preferential rates under both regular tax and AMT, realizing substantial capital gains can still affect your AMT liability indirectly. A large capital gain may push your total income over the AMT exemption threshold or phase-out range, resulting in a higher AMT liability.
- Do I need to file a separate form for AMT? Yes, to calculate and report AMT, you must complete Form 6251 and include it with your Form 1040. Form 6251 guides you through the process of determining your AMTI, applying the appropriate AMT tax rate, and calculating your AMT liability.
- Is AMT adjusted for inflation? Yes, the IRS adjusts the AMT exemption amount and the phase-out thresholds for inflation each year. This helps to reduce the number of taxpayers affected by AMT over time.
Work with a Harness Tax Advisor
Navigating the complexities of the Alternative Minimum Tax (AMT) system can be challenging, but with the support of Harness Tax Advisors and the Advisor Marketplace, you can make informed decisions to optimize your tax planning strategies. Harness Wealth’s team of experienced accountants and financial advisors can help you understand the nuances of AMT and build personalized tax and financial strategies to meet your unique goals and needs.
Whether you require in-depth guidance on tax planning and investment strategies, or just need some quick insights into equity compensation you may have, Harness Tax Advisors are here to help. If you may be subject to Alternative Minimum Tax or want to explore other tax planning opportunities, sign up for Harness Wealth today.