What is the AMT and How Does It Work?

What is the Alternative Minimum Tax (AMT)?

Congress initially enacted The Alternative Minimum Tax (AMT) to ensure that high-income taxpayers pay a minimum amount of tax.  It passed in 1969 in response to a report that high earners (the equivalent of $1.17 million a year in 2020) were not paying any tax at all. 

The AMT tax calculation is a parallel system to the regular tax system.  It has its own definition of income and expenses, rules for income recognition and timing, exemptions, and tax rates.  

Every taxpayer is subject to AMT rules, and the AMT results in more tax due if the AMT calculation is higher than the regular tax calculation.  

The AMT initially targeted the very highest earners, a fraction of the top 1% of earners.  The impact changes, however, with inflation and shifting rules.  At one point, up to 20% of taxpayers were subject to AMT.  Changes in 2017 reduced its impact by increasing income thresholds and adding a cost-of-living adjustment.  But, its effects on you will change as your income changes and tax laws shift.  

How AMT works

When you calculate your taxes, you actually calculate them twice, once with and once without AMT rules.  The AMT is different because it does not allow the Standard Deduction, personal exemptions, or many popular itemized deductions.  

Instead of the standard deduction, there is an AMT exemption which in 2021 will be $114,600 for a married couple filing jointly, $57,300 for those married filing separately and $73,600 for singles or head of household.  

The exemption begins to phase out for individuals with incomes over $523,600 and married couples with incomes over $1,047,200:

  • It also adds back in specific income streams that are not considered for regular income, such as the fair market value of incentive stock options that were exercised but not sold. 
  • Interest from some bonds that would otherwise be tax-exempt. 
  • Passive income and losses. 
  • Net operating loss deductions.  

After the adjustments, the AMT tax is 26% of income under a threshold and 28% of income over the threshold.  That threshold in 2021 will be $199,900 for married couples and $99,950 for singles.  

The AMT is more likely to affect married couples with children.  They often have a higher income, especially if both parents work and the AMT does not allow additional exemptions for additional household members (like children for example).  Also, this is one area in the tax code where there is still a marriage penalty. 

AMT Triggers

Several adjustments often lead to having to pay AMT.  They are often called “triggers,” but they aren’t actually triggering anything: they just adjust your income such that the AMT tax amount is more than the non-AMT amount, so you end up paying the higher AMT tax.  

Often, the items that trigger AMT include deductions for state and local taxes and the exercise of incentive stock options.  Other AMT adjustments and preferences include: 

  • State and local taxes paid from Schedule A (Form 1040).
  • State and local tax refunds reported on Form 1040. 
  • Specific investment interest expenses. 
  • Specific depletion expenses. 
  • Net operating losses. 
  • Interest from specific private activity bonds. 
  • Exercise of incentive stock options. 
  • Certain gains from property sales. 
  • Passive gains and losses. 
  • AMT loss limitations. 
  • Certain circulation costs. 
  • Long-term contracts. 
  • Certain mining costs. 
  • Specific research and experimental costs. 
  • Pre-1987 installment sale income. 
  • Intangible drilling cost preferences.   

Strategies to reduce AMT

If you are subject to AMT this year, you can’t change your situation for this year, but there are a few things you can do to reduce your exposure in future years. 

  1. If you are an employee, get your company to reimburse you for expenses rather than claim them as a deduction. This takes the expenses off of your tax return.  
  2. Pay your property taxes only when they’re due, and avoid prepaying your next installment by the end of the year.  If you prepay your taxes this year, you may have a higher deduction, which may trigger the AMT, and you will miss out on the deduction in the next year.  
  3. Strategically exercise incentive stock options over multiple years (such as the end of one and beginning of the next) so that the exercise of options does not trigger the AMT. Or sell exercised incentive stock options in the same year you exercise themIf you exercise the options but don’t sell, the value of the exercised options becomes income for AMT purposes, so you pay taxes but haven’t received the income. 

These strategies come with caveats and challenges, so I recommend that you consult an expert to help you navigate this tricky issue.  We can take a look at your taxes, let you know what your risks are, and help you craft strategies so that you pay the right amount.  

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