What’s the Alternative Minimum Tax (AMT), 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 155 people with an adjusted gross income over $200,000 had paid no federal income tax on their 1967 tax returns. The AMT was implemented so that high-income earners paid a fair tax bill. The AMT tax system is parallel to the standard tax system. It places a "floor" on the percentage of taxes a filer (individual or corporation) must pay to the government regardless of how many deductions are credits they may be claiming. The AMT is triggered when incomes go above the annual exemptions. For 2023, the exemption is $81,300 for single filers and $126,500 for couples filing jointly. The AMT recalculates income tax after adding specific income streams and tax preference items to your adjusted gross income. These items 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 tentative minimum tax exceeds the regular tax. Calculating the TMT is simple—the difference between a taxpayer's alternative minimum taxable income and their AMT exemption is taxed using the relevant rate schedule. Suppose the tentative minimum tax is higher than the taxpayer's regular tax liability for the year. In that case, the taxpayer will pay the total tentative minimum tax amount.There are two alternative minimum tax rates: 26% and 28%. In 2023, the 28% rate applies to the excess alternative minimum taxable income of $220,700 or more for all taxpayers ($110,350 for married couples that file separately). The 26% rate is for anyone with income up to those levels. 

How do I know if I need to pay AMT?

Taxpayers must complete IRS form 6251 to see whether or not they owe AMT. This form uses your medical expenses, home mortgage interest, and several other deductions to help determine if your deductions exceed the limit set by the IRS. This form will also request information on income like tax refunds, investment interest, and capital gains related to the disposition of property.The form will walk you through how to subtract the exemption amount from your income, and if your AMT is less than the exemption, you don't have to pay AMT.However, taxpayers with AMTI over a certain threshold do not qualify for AMT exemption. In the 2023 tax year, the phase-out begins at $578,150 for single filers and $1,156,300 for married couples filing jointly.

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 if it will affect you this upcoming year.