What’s the Alternative Minimum Tax, and When Will You Have to Pay It?

The alternative minimum tax (AMT) is another way to calculate a high-income earner’s tax bill. Let’s take a closer look at when an AMT is triggered, the intricacies of this method, and, most importantly, how to determine whether you need to pay.

What is the AMT?

The alternative minimum tax (AMT) was introduced in 1969 after the Secretary of the Treasury testified that some high-income taxpayers had paid little to no federal income tax. The AMT ensures that individuals and corporations with higher incomes pay a minimum level of taxes, regardless of deductions or credits.

The AMT system runs parallel to the standard tax system and sets a “floor” on the percentage of taxes a filer must pay. It is triggered when income exceeds the AMT exemption, which is adjusted annually for inflation. The AMT recalculates income tax by adding certain income streams and tax preference items back to your adjusted gross income. These items may include:

  • Interest in private activity municipal bonds

  • Small business stock exclusions

  • Excess intangible drilling costs for oil and gas

Those types of deductions are added to the taxpayer’s income to calculate their alternative minimum taxable income (AMTI). The AMT exemption is subtracted to give the final taxable amount. 

How does the AMT work?

The AMT is the excess of the tentative minimum tax (TMT) over the regular tax and is owed only if the TMT exceeds the regular tax. Calculating the TMT involves subtracting the AMT exemption from your alternative minimum taxable income and applying the relevant rate schedule.

There are two AMT rates: 26% and 28%. The 28% rate applies to income above certain thresholds, while the 26% rate applies to income below those thresholds. These thresholds are adjusted annually for inflation. If your TMT exceeds your regular tax, you pay the total TMT amount.

How do I know if I need to pay AMT?

Taxpayers must complete IRS Form 6251 to determine whether they owe AMT. This form considers medical expenses, home mortgage interest, and other deductions to see if they exceed the IRS limits. It also requests information on income, such as tax refunds, investment interest, and capital gains related to property dispositions. The form guides taxpayers through subtracting the exemption amount from income, and if the AMT is less than the exemption, no AMT is owed. Taxpayers with alternative minimum taxable income over certain thresholds do not qualify for the AMT exemption. For full details, see the IRS Form 6251 instructions.

Can you avoid or reduce the AMT?

The strategic design of the AMT makes it difficult for taxpayers to escape it. Once you file your return and discover that you owe AMT, there isn’t anything you can do to avoid it. However, you can prepare for the following year by lowering your adjusted gross income in several ways:

  • Contribute to a health savings account and max it out if possible

  • Max out retirement accounts such as your 401(k) or IRA

  • Donate appreciated securities to charities approved by the IRS

One of the most common scenarios where taxpayers are vulnerable to the AMT is in cases where Incentive Stock Options are exercised during the year. In any year you exercise ISOs, pay special attention to the AMT and ensure that the tax preparer or tax software runs an AMT calculation. Due to the complexity of this tax process, we recommend using a tax preparer to run these calculations instead of trying to do it yourself. Contact our team to learn more about the alternative minimum tax and whether it will affect you.

This commentary reflects the personal opinions, viewpoints, and analyses of The Dala Group, LLC employees providing such comments. It should not be regarded as a description of advisory services provided by The Dala Group, LLC or performance returns of any The Dala Group, LLC client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The Dala Group, LLC manages its clients’ accounts using various investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Mike Heatwole, CFP®, AWMA®

Mike Heatwole is a Certified Financial Planner™ and the founder and CEO of The Dala Group. He built the firm with a focus on helping families achieve their lifestyle and legacy goals through comprehensive wealth management and strategic financial planning.

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