AMT what? Alternative Minimum Tax is the minimum percentage of tax that a taxpayer must pay to the government, no matter how many deductions or credits they claim. It's a separate tax system that requires some taxpayers to calculate their tax liability twice—first, under ordinary income tax rules, then under the AMT—and pay whichever amount is highest. Said differently, it’s a side-by-side calculation used by the IRS to determine if we are paying our fair share of taxes by considering “add back items” and “preference items” such as the bargain element on Incentive Stock Options. It can be complicated, but let's discuss how it might impact you.
What is alternative minimum tax (AMT)?Range
One Forbes columnist calls it “the normal tax system’s evil twin.” The Tax Policy Center has labeled it “the epitome of pointless complexity.” Nine recent presidential candidates – ranging from Marco Rubio to Bernie Sanders – have pledged to eliminate it.
First, let's acknowledge that it impacts a very small number of U.S. taxpayers.
If a household makes less than $200,000 a year, it is very unlikely that it will be subject to the AMT. Among households making between $100,000 and $200,000, only 3.8% fell under the tax.
Nevertheless, the AMT remains a part of the U.S. tax code, and over 3.9 million households are subject to it every year. What do we know about these households?
There are a couple other important characteristics of households that typically fall under the AMT:
The alternative minimum tax runs parallel to the standard tax system, but it has a different tax rate structure that eliminates some common tax breaks.
How do I calculate my alternative minimum tax liability?
First of all, we don't recommend trying this on your own! All tax software will do this for you behind the scenes as you input your income and deductions during tax prep time. If you hand your taxes of to a Certified Public Accountant (CPA) every year, they should also have a working knowledge of all of the considerations here.
Calculate your taxable income, but with fewer tax exclusions and tax deductions, as dictated by the AMT rules (IRS Form 6251 has the details on which tax breaks get the ax in the AMT calculations.)
Once you have that AMT version of your taxable income, subtract the AMT exemption amount.
Multiply what’s left by the appropriate AMT tax rates. The AMT has two tax rates: 26% and 28%. (Compare these to the seven federal income tax brackets, ranging from 10% to 37%.) Which rate you pay depends on how high your AMT taxable income is.
There are only two AMT tax rates as of 2022 are 26% and 28%. The 28% AMT rate applies to taxpayers with AMT-calculated incomes of $206,100 as of the tax year 2022. The same rate applies whether you're single or filing a joint married return.
Subtract the AMT foreign tax credit (if you qualify for it). What’s left is your income tax under the AMT rules.
If your income tax under the AMT rules is higher than your income tax under the regular rules, you pay the higher amount. This basically determines who has to pay alternative minimum tax.
What tax breaks do you lose under the AMT?
Taxpayers typically look for deductions, credits and other ways to reduce their taxable income. Under the AMT, you may not be able to take as many of these breaks.
Other income streams that may be included in AMT calculations include:
Deductions for state and local taxes (such as property taxes) are targets, for example. A range of business items are curtailed.
Investors also could face AMT depending on the nature of their investment income. Long-term capital gains and certain dividends could push your income up into the AMT system.
What happens with AMT and incentive stock options (ISOs)?
Incentive stock options (ISOs) are a type of tax-advantaged stock granted to employees to buy shares, typically at a price lower than the fair market value.
ISOs can be taxed as long-term gains, instead of regular taxable income.
If you hold ISOs until at least one year after exercise and two years after the grant date, they aren’t taxed as regular income. This is known as a "Qualifying Disposition". As opposed to ordinary income treatment, they will be treated as long-term capital gains and the savings are significant: as much as 20% depending on your income bracket.
That said, you may need to pay an alternative minimum tax. The catch with ISOs is you’ll need to file an AMT adjustment on the “bargain element". The bargain element is the difference between the price you pay to exercise the shares and their fair market value at time of exercise. This may trigger you to pay more in taxes than you would otherwise. When you’re determining how and when to exercise and sell your ISOs, you’ll want to take into account the AMT adjustment.
Both depend on when you sell your ISOs. By choosing when you sell your shares, you can avoid the AMT adjustment or opt for the long-term capital gains tax advantage.
You exercise Incentive Stock Options (ISOs) to purchase 100 shares of stock at $3 per share and you decide to hold the stock as a long-term investment. The stock is trading at $33 per share on the day of the exercise. Line 15 on your Form 6251 is $3000 (100 shares x ($33-$3 per share).
Your basis in this stock is now $300 ($3 x 100) for regular tax purposes, but $3,300 ($33 x 100) for AMT purposes. When you later sell the stock, you will have an entry on Line 18, Disposition of Property Difference, to account for the difference in your tax basis for regular and AMT purposes.
Suggestion 1: If you exercise ISOs as in the previous example at $33 and the stock falls before the end of the current year, you can sell the stock and avoid the AMT. If the stock fell to $25 during the year of the exercise, you would be subject to regular tax on only $22 per share ($25-$3) and not be subject to the AMT adjustment at all.
Suggestion 2: When you exercise ISOs, always use tax planning software to forecast the tax consequences. You may need to sell some of the stock in the year of the exercise to pay the tax due.
When we exercise ISOs and pay AMT on the bargain element, the difference between the exercise price and the fair market value, what happens to the tax payment? The tax payment is an AMT credit and may be used against regular tax in future years. “Am I Eligible for a Tax Credit? If you're not liable for AMT this year, but you paid AMT in one or more previous years, you may be eligible to take a special minimum tax credit against your regular tax this year. If eligible, you should complete and attach Form 8801, Credit for Prior Year Minimum Tax - Individuals, Estates, and Trusts to claim the minimum tax credit.”
We did our best to layout the considerations for the following questions:
There are some things you can do to plan ahead for the Alternative Minimum Tax:
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