Alternative Minimum Tax (AMT)
The alternative minimum tax (AMT) was originally enact-ed to ensure that high-income taxpayers pay at least a min-imum amount of tax if they benefit from certain deductions and other tax preference items.
The AMT tax computation is a parallel system to the reg-ular tax system with its own definitions of income and ex-penses, rules for income recognition and timing, exemp-tions, and tax rates. Although every taxpayer is subject to AMT rules, the additional tax is paid only if the tax com-putation under AMT rules is higher than the tax computed under regular rules.
Even though the AMT was originally targeted toward high-income taxpayers, factors, including inflation and treatment of certain tax credits, can sometimes push low-er-income taxpayers into an AMT situation.
How AMT Works
Certain items, called adjustments and preferences, are added to or subtracted from federal adjusted gross income reduced by any itemized deductions. An AMT exemption amount is allowed, depending on the taxpayer’s filing sta-tus. The AMT tax rate of 26% to 28% is applied to the re-sulting alternative minimum taxable income. If the result-ing tax is greater than regular tax, the difference is added to regular tax on Form 1040.
Example #1: When computed under regular rules, John’s in-come tax is $4,700. When computed under AMT rules, the tax amount is $3,900. Since his tax computed under AMT rules is less than his tax computed under regular rules, John will not pay any additional amount for AMT.
Example #2: Assume the same facts as Example #1, except when computed under AMT rules, John’s tax amount is $5,100. Since his tax computed under AMT rules is higher than his tax comput-ed under regular rules, John must pay the difference in additional tax. John must report additional AMT tax in the amount of $400.
Items that commonly trigger AMT include high gross in-come relative to taxable income and exercise of incentive stock options. Other AMT adjustments and preferences include:
AMT Exemption Amounts
|Single or Head of Household||$81,300||$81,300|
|Married Filing Jointly or Qualifying Surviving Spouse||$81,300||$81,300|
|Married Filing Separately||$81,300||$81,300|
Incentive Stock Options—AMT Adjustments
The bargain element resulting from exercise of incentive stock options (ISO) is equal to the fair market value (FMV) of the stock minus the exercise price and is a deferral item for AMT purposes.
|Event||Regular Tax Treatment||AMT Adjustment|
|Exercise of ISO||No tax due on ISO exercise.|
• Positive AMT adjustment on line 2i, Form 6251, equal to bargain element.*
• Increase AMT basis of stock by amount of adjustment.
|Sale of stock||Tax treatment depends on whether required holding period is met.||• Negative AMT adjustment on line 2k, Form 6251, equal to bargain element.*|
• Adjustment is result of previous increase in AMT basis.
* No adjustment is made if exercise and sale occur in the same tax year.
Form 3921, Exercise of an Incentive Stock Option Under Section 422(b), may help in computing the adjustment.
Example #1: Cindy exercised an ISO to acquire 100 shares of stock in 2023. Her rights in the acquired stock first became transferable on the date she exercised the ISO and were not subject to a sub-stantial risk of forfeiture. She did not pay anything for the ISO and did not sell the acquired stock during 2023.
Cindy received Form 3921 that shows $10 in box 3 (the exercise price paid for each share), $25 in box 4 (the fair market value of each share on the exercise date), and 100 shares in box 5 (the number of shares acquired). To calculate the adjustment, multiply the amount in box 4, $25, by the 100 shares in box 5. The result is $2,500, the fair market value of all the shares. Then multiply the amount in box 3, $10, by the 100 shares in box 5. The result is $1,000, the amount paid for all the shares.
Cindy’s AMT adjustment is $1,500 ($2,500 − $1,000).
Potential tax credit
If the AMT adjustment due to exer-cise of an ISO results in an AMT liability, an AMT credit may be available in subsequent tax years.
An individual can claim nonrefundable personal credits against regular tax and AMT.
Nonrefundable Personal Credits
|America Opportunity Credit and Lifetime Learning Credit||8863|
|Child and Dependent Care Expense Credit||2441|
|Child Tax Credit||Sch. 8812|
|Clean Vehicle Credit||8936|
|Credit for Other Dependents||Sch. 8812|
|Credit for the Elderly or the Disabled||Sch. R|
|Energy Efficient Home Improvement Property Credit||569|
|Foreign Tax Credit (see Foreign Tax Credit and AMT, below)||1116|
|Mortgage Interest Credit||8396|
|Retirement Savings Contributions Credit||8880|
Foreign Tax Credit and AMT
The AMT treatment of the Foreign Tax Credit depends on whether Form 1116, Foreign Tax Credit, is being filed.
|Taxpayer elects not to file Form 1116.||• Report Foreign Tax Credit on Schedule 3 (Form 1040).|
• Credit is limited to amount of regular tax.
• Unused Foreign Tax Credit may not be carried over.
|Taxpayer files Form 1116.||• Recalculate Foreign Tax Credit using AMT rules.|
• AMT Foreign Tax Credit is used to offset AMT on Form 6251.
• Unused AMT Foreign Tax Credit may be carried back one year and carried forward 10 years.
Credit for Prior Year AMT
The adjustments and preferences that result in AMT are of two types.
The potential exists for income from deferral items to be taxed twice — first under AMT, and again in a later year un-der regular tax. A credit against regular tax for prior year AMT is available to address this situation.
There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves sum-marizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact us in advance if you have questions about the tax effects of a transaction or event, including the following:
*This post contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information.