Alternative Minimum Tax (AMT)
Taxation is complex. We provide below what we believe are the key highlights for this tax type in a 2-3 minute read for reference purposes. It is not tax advice and does not discuss the vast majority of the finer points.
AMT is one of the most commonly misunderstood tax dynamics; it's also the tax item our team at 30-40 Wealth gets the most questions on and sees incorrectly inputted the most often (including on returns prepared by CPAs). If you have ISOs and are trying to understand the AMT implications, we strongly recommend working with a financial advisor and CPA who understands it well.
What Is Alternative Minimum Tax? When/How Does It Apply?
Alternative Minimum Tax (AMT) is a parallel federal tax system in the US. Every year when you calculate and file your taxes, two calculations are conducted (standard and AMT), and you owe/pay the higher of the two. Many AMT inputs and calculations work exactly the same as standard tax; but AMT will differ in four primary areas:
Certain deductions and credits are disallowed for AMT. AMT originally came into being to help ensure wealthy individuals who were over-using deductions and credits paid a fair share. This dynamic continues to exists today--with some deductions and credits that apply for standard tax not applying for AMT.
Different applicable tax rates (26% or 28%). AMT rates start at 26%, and increase to 28% above a certain income amount (but never goes any higher). This is a very different graduated tax schedule versus standard federal income tax rates that currently range from 10% to 37%.
AMT has a large standard deduction. The AMT calculation includes a deduction of around $81,300 for individuals and $126,500 for married couples (as of 2023). This deduction is often what results in a household's standard tax liability exceeding their AMT liability (and thus a household owing the standard calculation instead of any AMT).
If you owe AMT, you also get a recoupable tax credit. AMT is sometimes known as a "prepayment tax." If your AMT calculation (e.g. $270k) is greater than your standard calculation (e.g $230k), you pay the higher amount (e.g. $270k), but you also get a credit for the difference (e.g. $270k - $230k = $40k), which can be recouped in future years:
Exercising ISOs Is What Frequently Triggers Amt for Tech Professionals
As noted above, certain deductions are disallowed for AMT. For tech professionals, the differing treatment when ISOs are exercised is what most frequently results in tech professionals owing AMT. Specifically, the bargain element when you exercise ISOs is considered income for AMT, but is not for standard tax (unless you conduct a disqualifying disposition in the same year).
What Are the Current Tax Rates/Brackets?
AMT Tax Rates
| Tax Rate | Income |
|---|---|
26% | Up to $210,700 |
28% | Over $210,700 |
AMT Deductions and Phase Outs
| Single | Married Jointly | Married Seperate | |
|---|---|---|---|
Exemption Amount | $81,300 | $126,500 | $63,250 |
Phase Out Begins | $578,150 | $1,156,300 | $578,150 |
Fully Phased Out | $858,500 | $1,592,500 | $796,250 |
IMPORTANT: The AMT deduction phases out at high incomes. In most situations the phase out will not result in AMT being owed vs. standard tax (due to high income being taxed at high rates; e.g., 37% max income tax bracket for standard tax vs. 28% max for AMT). But it can be a surprise, and also a tax planning focus if you are exercising ISOs or have an AMT credit that you are seeking to recoup.
What Type of Stock Compensation Does AMT Apply To?
| Stock Comp Type | AMT Applicability |
|---|---|
ISOs | Potentially. When ISOs are exercised, the spread between the exercise price and the fair market value of the stock is included in AMT income calculations, but not regular taxable income calculations. For more info see: ISO Stock Options |
NSOs | Very unlikely. Normally do not trigger AMT*. For more info see: NSO Stock Options |
RSUs | Very unlikely. Normally do not trigger AMT*. For more info see: Restricted Stock Units (RSU) |
ESPPs | Very unlikely. Normally do not trigger AMT*. For more info see: Employee Stock Purchase Plan (ESPP) |
RSAs | Very unlikely. Normally do not trigger AMT*. For more info see: Restricted Stock Award (RSA) |
SARs | Very unlikely. Normally do not trigger AMT*. For more info see: Stock Appreciation Right (SAR) |
Phantom Stock | Very unlikely. Normally do not trigger AMT*. For more info see: Phantom Stock |
*Any stock-based compensation that creates income will technically have an AMT impact. However we detail these are "very unlikely" because both standard and AMT calculations are impacted (which all else equal, usually means AMT will not be triggered)
Unique Items and Special Situations
Recouping Your AMT Credit Follows Specific Calculation Rules
An AMT credit is eligible for recoup up to the amount in which your standard tax calculation exceeds your AMT tax calculation. The AMT credit will offset the amount you would otherwise owe for standard income taxes. And any unrecouped amount will roll forward to future years.
For example, if you paid an incremental $20,000 of tax last year due to AMT, you have a $20,000 AMT credit with the IRS. If your standard tax calculation this year is $50,000 and your AMT calculation is $42,000:
You owe $50,000 in tax (the higher of the two calculations)
You will be able to recoup/use $8,000 ($50k - $42k) of your AMT credit to pay your tax bill (or get a refund if your withholdings plus the AMT credit recoup exceeds $50k)
Your AMT credit will have been reduced to $12k, and that will roll forward to the next year
Note: Any AMT credit at the time of death is lost.
ISO-Acquired Shares Likely Have 2 Cost Basis; and Selling ISO-Acquired Shares Can Accelerate AMT Credit Recoup
Exercising ISOs can trigger AMT because the bargain element is considered income for AMT, but not standard tax. What's a bit unique (and complicated), however, is that if a bargain element exists when an ISO is exercised, that results in your ISO-exercised shares having two different tax basis (one for standard tax and one for AMT). And this dual-basis dynamic is a benefit to you.
Assuming the shares are held to achieve an ISO qualifying disposition, when you sell the shares the long-term capital gain you have for standard tax will differ (be higher) than for AMT tax. All else equal, this will make your standard tax calculation incrementally larger than your AMT tax calculation --> helping you to recoup a larger portion of the AMT credit you have with the IRS.
AMT Credit Recoup Can Get Complicated if ISO-acquired Shares are Sold for an AMT Loss
AMT rules frequently follow standard taxation rules, unless explicitly different. In standard taxes, a max of $3k per year of capital losses can be used to offset income. This same limit applies to AMT. With the dual cost basis dynamic noted above, if ISO-acquired shares are sold for loss for AMT calculations, they will be subject to the $3k per year rule -> which can complicate credit recoup. More details can be found here: Pair Capital Gains with AMT Capital Losses
Some States Have Their Own Version of AMT
In addition to federal AMT, some states also have their own version of (and rules for) a minimum tax. If you live in a state that has AMT, you should ensure you consider this in your overall tax strategy.
Long-term Capital Gains and Dividends Can Trigger AMT
Even though long-term capital gains and dividends are taxed at preferential long-term-capital-gain tax rates, they are still included as income for the purpose of the AMT credit phase out. This can result in some households that have a very large long-term capital gain owing AMT, even though they did not exercise any ISOs.
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