Originally Published August 23, 2022, Updated June 19, 2024.
It's common for high-income taxpayers to do what they can to minimize the amount of taxes they pay. They can do so in various ways by reducing their taxable income, timing the sale of long-term capital gains, or taking deductions. However, some limits in place may curb some of the tax benefits otherwise available. The Alternative Minimum Tax, or AMT, is one such limit on tax breaks.
At CMP, we work with high earners daily to help them take advantage of all available tax deductions and tax credits. The Alternative Minimum Tax is something that can be confusing since it generally affects only high-income earners. We've created this overview to help you understand what the AMT is how it works—and how you can offset what you pay with the AMT credit.
The Alternative Minimum Tax was first established back in 1969 to prevent the wealthiest taxpayers from avoiding paying taxes. Treasury Secretary Joseph Barr testified before Congress that in 1966, 155 wealthy Americans had paid nothing in taxes. Congress had to make a choice. They considered eliminating some of the tax preferences that accrue to high-income taxpayers but decided against that in favor of creating a minimum tax.
Taxpayers in the highest brackets must calculate their taxes in two ways to determine whether they must pay the AMT. They calculate the standard way, then recalculate tax after applying AMT adjustments, and tax must be paid based on the higher of the two results.
To calculate the AMT and determine whether they need to pay it, taxpayers must add certain deductions back into their income to calculate the Alternative Minimum Tax Income (AMTI). Once they have done that, they subtract the allowed exemptions.
The AMT exemption amounts are as follows.
If their AMT is less than the exemption after subtracting the AMT exemption, they are not required to pay AMT. However, there are exceptions for the highest earners. Any taxpayer with an AMTI over the specified threshold does not qualify for the AMT exemption.
The phase-out for the AMT exemption starts at $578,150 for individuals and $1,156,300 for married couples filing jointly for the 2023 tax year—those amounts for the 2024 tax year increase to $609,350 and $1,218,700 respectively.
After a taxpayer calculates their AMT and applies for the exemption, both single and married taxpayers will be taxed at a rate of 26% on AMTI below $197,900 and 28% for income $197,900 and over.
More details on the graphic below.
*graphic courtesy of NerdWallet
You will need to use IRS Form 6251 to determine whether you need to pay the Alternative Minimum Tax. You can find the form and instructions here.
When you look at the form, you will note that Line 2 contains a large list of line items (or adjustments) that you must enter to determine whether you are required to pay the AMT. Some of these items cannot be used toward an AMT credit, including tax payments and home equity mortgage interest.
Some high-income earners use Form 6251 to keep track of their income and try to anticipate whether they will need to pay the AMT in any given year. We will talk more about that later.
Perhaps the biggest downside of the AMT is that it requires high-income taxpayers to pay taxes on some income, even if it hasn't been earned. The most common situation where the AMT applies is when an individual or married couple has incentive stock options (ISOs.)
Let's look at an example to explain why an ISO might lead to you needing to pay the AMT even if you haven't realized the income from them. Say you had 150 ISOs ready to exercise. The strike price might be only $3 per share for a total value of $450, but the fair market value of the stocks might be $300 per share for a potential sale value of $45,000.
That means you have a cost basis of $450 while the shares have a market value of $45,000. By subtracting the cost basis from the market value, you can see an unrealized profit of $44,550. You could be on the hook to pay $11,583 in AMT if you fall into the income bracket for the 26% rate.
The AMT credit allows you to offset your eventual capital gain when you sell those stocks by applying your previously paid AMT against your capital gains tax.
Qualification for the AMT credit is based on whether an amount you paid AMT for is deferred or excluded. Excluded items may not be recouped with the AMT credit, but deferred items may be.
Here is a list of items that qualify as deferred and can help you qualify for the AMT credit.
Some examples of AMT exclusions include the following items.
AMT exclusions are never creditable under AMT rules. If you have paid AMT taxes on these items, no mechanism will allow you to get the money back.
There is a limit on how much AMT credit you can claim in a single year. When you file your tax return, you will need to calculate your regular tax liability. If you paid AMT on your ISOs and then sold them in another year, you would need to calculate your regular tax liability for that year.
The amount of AMT credit you can take in any given tax year is limited. You may not take an AMT credit that would result in you paying less than your regular tax liability as calculated based on your earnings in the year.
What that means is that if you have paid a high amount of AMT due to ISOs or another unrealized profit, it could take you years to recover your entire credit. Fortunately, it is possible to carry the credit forward. We will talk about that next.
As we mentioned in the previous section, there is an option to carry the AMT credit forward to years when you have realized income on items that you previously were required to pay the Alternative Minimum Tax.
Because of the annual limitations on the AMT credit, it may take several years to claim the entire credit you are due. As we noted above, you may only claim an amount that would reduce your taxes to the amount of your regular tax liability. You should also know that you may only claim an AMT credit in a year when you are not required to pay AMT.
Keep in mind that you must omit any exclusion items when calculating your AMT credit. When the original AMT was created, the carryforward period was six years. If you could not claim your entire credit in six years, any remaining amounts of AMT that you paid were forfeited.
Under current tax law, you can carry forward your AMT credit for up to 20 years. For most taxpayers, that length of time will be sufficient to ensure that they can claim the entire credit due to them.
Claiming the AMT credit can be a complex process due to the necessity of evaluating the various income sources and determining which sources are deferred items versus exclusion items. As a reminder, only deferred items may be used to determine how much the AMT tax credit is and claim the credit.
You will need to use Form 8801 to calculate and claim the AMT tax credit. You can find the form and instructions on the IRS website here.
As noted above, you must also use Form 6251 to determine whether you must pay AMT. If you are not, then you will pay the amount of your regular tax liability. However, you should still use Form 8801 to calculate the amount of the credit you are due. You can carry it forward to your next eligible tax year for a maximum carry-forward of 20 years.
We should note that many taxpayers, even those with some financial expertise, find the laws and calculations regarding the AMT credit to be confusing. We suggest working with an income tax professional to ensure that your calculations are correct and that you claim the maximum credit you are due.
The Tax Cuts and Jobs Act of 2017 expanded the carryforward period for the AMT credit. As of 2007, the AMT credit could only be carried forward for a maximum of six years. The TCJA increased the AMT tax carryforward option to 20 years, making it far easier for those required to pay the AMT to recoup some of their taxes in subsequent years.
We always monitor changes in the tax code and will update this post if the carryforward period changes.
We'll close with a few tips to help you anticipate your AMT liability in years when you are required to pay the AMT and to ensure that you calculate your AMT credit properly and claim the allowable amount.
The most important advice we can give you is to work with an experienced tax professional to calculate your AMT and AMT credit. As we noted above, the calculations required to complete your income tax return when the AMT or AMT credit applies are complex, and getting the details right is essential. This will also require you to save copies of prior year tax returns and Forms 6251.
The Alternative Minimum Tax can increase the complexity of filing your tax return and add to your tax bill. You can recoup some of the amounts you pay using the AMT tax credit, which, as of 2024, may be carried forward for up to 20 years.
Do you need assistance calculating your AMT or AMT credit? CMP has the experience to help!