If you have equity comp or a 7-figure income, you need to be aware of the Alternative Minimum Tax (AMT).
Otherwise, you could find yourself with an unexpected tax bill and no liquidity to pay it.
This post aims to help you understand AMT so you can avoid being blindsided by it.
What is the Alternative Minimum Tax?
The AMT isn’t an extra tax like the 3.8% Net Investment Income Tax (NIIT) or the 0.09% Medicare surtax.
AMT is the IRS' way of saying, "Okay, we did the regular tax calculation. Now, let’s do a different calculation to make sure you’re paying what we think you should."
So, what's different about the AMT calculation? AMT takes your regular taxable or adjusted gross income (AGI), then:
Adds back or reduces the value of certain deductions
Adds income not taxed in the regular tax calculation
Subtracts the AMT exemption
Uses 26% & 28% tax rates
If the AMT calculation is less than the regular tax, you pay the regular tax. If AMT exceeds the regular tax calculation, you'll owe AMT. For example:
Regular tax = $30,000; AMT = $25,000 - You pay $30,000 regular tax
Regular tax = $30,000; AMT = $35,000 - You pay $30,000 regular tax + $5,000 AMT
Common AMT Triggers
AMT is specifically applicable to those with Incentive Stock Options (ISOs) because of how the bargain element is treated for regular tax and AMT purposes. For an in-depth explanation of how ISOs and AMT interact, read The Executive's Guide to Incentive Stock Option (ISO) Taxation.
Other common AMT triggers include:
Large amounts of accelerated depreciation
High amount of tax-exempt income from private activity bonds
Large deductions for Net Operating Loss (NOL) and/or passive activity losses (PALs)
AMT Reductions and Add-backs
Some of the deductions allowed in the regular tax calculation are added back or reduced when determining AMT Income (AMTI). Common deductions you might recognize include:
Depreciation
Investment interest expense
State, local, & property taxes
Net operating loss deduction
Standard deduction (if you don't itemize)
AMT Exemptions and Phaseouts
Once AMTI is calculated, you may be able to subtract an AMT exemption, which reduces the amount of income subject to the AMT rates.
However, the exemption is reduced by 25 cents for every dollar over the threshold until it's eliminated. The 2024 phaseout and elimination thresholds are shown below.
Next, the remaining income is applied to the AMT tax rates.
AMT Calculation
Similar to the regular tax calculation, long-term capital gains and qualified dividends are separated and taxed at lower rates. However, all ordinary income is taxed at two rates.
In 2024, income below $232,600 is taxed at 26%, and income above that is taxed at 28%.
This calculation is done on IRS Form 6251 (part 2 shown below). The regular tax (line 10) is subtracted from the tentative minimum tax (line 9). Any remainder is the amount of AMT you owe.
It's important to recognize that the AMT is the excess after subtracting the regular tax, not the whole amount calculated on line 9. This comes into play when determining your potential AMT credit.
AMT Credit
If you're subject to AMT due to a "timing item," you'll receive an AMT credit. A timing item is something you paid AMT tax on in one year that will be subject to regular tax in the future.
A common example is when you hold exercised ISOs into the next tax year and the bargain element causes you to pay AMT. Then, if you sell the shares in a qualifying disposition your capital gain is higher for regular taxes because the bargain element isn't included in your regular tax basis.
Despite it's name, the credit is actually applied in a year(s) when you don't pay AMT. To claim the credit, you MUST file IRS Form 8801. In addition, you must file the form every year to carry the unused credit to future tax years until it's completely exhausted.
If you fail to track the credit, you may end up paying thousands in extra taxes.
Conclusion
AMT is a complex topic as a result of complex situations. It's very hard to avoid AMT if you're subject to it, but understanding its nuances can help you form a plan and avoid being blindsided with little to no liquidity.
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