Alternative Minimum Tax (AMT)

In a nutshell: The AMT is a parallel tax system designed to ensure that high-income individuals and corporations pay a minimum amount of tax, even if they have significant deductions or credits that would otherwise reduce their regular tax liability. Think of it as a separate tax calculation that might kick in if your income and deductions fall within certain parameters. It’s not something everyone needs to worry about, but it’s wise to understand how it could affect you if your equity gains significantly increase your income.

How does the AMT work?

The AMT calculates your tax liability using a different set of rules than the regular income tax system. It starts with your regular taxable income, but then adds back certain deductions and exemptions that are allowed under the regular tax system, such as:

• Standard deduction: If you itemize on your taxes, the AMT may add part of the standard deduction back. This results in higher taxable income from the AMT’s perspective and it is used to calculate the AMT.
• State and local taxes: Deductions for state and local income, sales, and property taxes (SALT) are added back as the AMT’s calculation attempts to level the playing field across varying state taxes.
• Certain itemized deductions: Some itemized deductions allowed under the regular tax system, such as miscellaneous itemized deductions subject to the 2% AGI limit, are not allowed under the AMT.
• Tax-exempt interest from certain private activity bonds: These are bonds issued by or on behalf of local or state governments for private entities, where the private entity benefits from more than 10% of the proceeds of the bond issuance. This is designed to incentivize certain private sector investments, usually in infrastructure.

After adding these items back to your income, the AMT calculation applies its own exemption amount and tax rates to determine your AMT liability. If this amount is higher than your regular tax liability, you pay the AMT amount instead.

Who is most likely to be affected by the AMT?

While anyone could theoretically be subject to the AMT, it’s more likely to affect individuals with:

• Large incomes: As your income rises, you’re more likely to have deductions and exemptions that could trigger the AMT.
• Significant equity compensation: Exercising a large number of incentive stock options (ISOs) or selling a significant amount of company stock can lead to a large increase in income, potentially making the AMT applicable.
• High state and local tax deductions: Residents of high-tax states may be more susceptible to the AMT due to the add-back of state and local tax deductions.

How can I plan for the AMT?

It’s impossible to predict the future, but if you anticipate a liquidity event that could significantly impact your income, consider these steps:

• Consult with a tax advisor: A qualified tax professional can help you understand the potential implications of the AMT on your specific situation and develop strategies to minimize its impact.
• Model different scenarios: Use online calculators or work with your tax advisor to estimate your tax liability under both the regular and AMT systems.
• Consider the timing of your liquidity event: In some cases, strategically timing the sale of your shares could help minimize your AMT liability.

So here’s what we covered:

• What the AMT is and how it works.
• Who is most likely to be subject to it.
• How to plan for the AMT and mitigate its potential impact.

Learn More: Incentive Stock Option (ISO) Learn More: Non-Qualified Stock Option (NSO) Learn More: Tax Basis Learn More: Capital Gains Tax