3.4 Alternative minimum tax (AMT)

The Alternative Minimum Tax (AMT) ensures high-income taxpayers pay a minimum tax amount. It creates a parallel tax system with its own rules, adding back certain deductions and applying different rates to a broader income base.

Calculating AMT involves determining alternative minimum taxable income, applying exemptions, and comparing the result to regular tax liability. Various factors can trigger AMT, including large state tax deductions, exercising stock options, and certain types of investment income.

The Alternative Minimum Tax

Purpose and Mechanics of AMT

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• Alternative Minimum Tax (AMT) operates as a parallel tax system ensuring high-income taxpayers pay a minimum tax amount
• AMT prevents wealthy individuals from using excessive deductions and credits to reduce tax liability
• Creates alternative minimum taxable income (AMTI) by adding back certain tax preference items and adjustments to taxable income
• AMT rates apply lower than regular tax rates but cover a broader income base due to addbacks and adjustments
• Taxpayers calculate both regular tax and AMT liability, paying the higher amount
• AMT system includes its own exemptions phasing out at higher income levels (potentially increasing AMT liability for high earners)

AMT Calculation Process

• Start with regular taxable income and add back AMT adjustment items and tax preference items to determine AMTI
• Apply AMT exemption amount (varies by filing status and subject to phase-out)
• Calculate tentative minimum tax using AMT rates (26% and 28%) on AMTI exceeding exemption
• Compare tentative minimum tax to regular tax liability
• If tentative minimum tax exceeds regular tax, difference becomes additional AMT owed
• Use Form 6251 for AMT calculations and liability determination
• Analyze potential AMT credit availability for future years (triggered by certain deferral items)

AMT Liability Triggers

Deductions and Income Sources

• Large state and local tax (SALT) deductions trigger AMT liability (not allowed under AMT system)
• Exercising incentive stock options (ISOs) without same-year share sale increases AMT exposure
• Significant miscellaneous itemized deductions eliminated under AMT raise AMT likelihood
• High levels of long-term capital gains or qualified dividends push taxpayers into AMT territory (AMT exemption phase-out rules)
• Accelerated depreciation claims on certain assets may trigger AMT (AMT requires different depreciation methods)
• Large medical expense deductions contribute to AMT liability (AMT threshold for medical expenses exceeds regular tax threshold)
• Tax-exempt interest from certain private activity bonds increases AMT exposure (taxable under AMT rules)

Additional AMT Triggers

• Home equity loan interest deductions (not allowed for AMT if loan not used for home improvements)
• Personal exemptions and standard deductions (disallowed under AMT)
• Passive activity losses (treated differently under AMT rules)
• Foreign tax credits (limited under AMT calculations)
• Net operating loss deductions (limited to 90% of AMTI)

AMT Calculation vs Regular Tax

Regular Tax Calculation

• Determine gross income from all sources (wages, investments, business income)
• Subtract above-the-line deductions to calculate adjusted gross income (AGI)
• Apply either standard deduction or itemized deductions to AGI
• Subtract personal exemptions (if applicable) to arrive at taxable income
• Apply progressive tax rates to taxable income (10%, 12%, 22%, 24%, 32%, 35%, 37% for 2021)
• Calculate tax credits to reduce tax liability (child tax credit, education credits)

AMT Calculation Steps

• Begin with regular taxable income as starting point
• Add back AMT adjustments (state and local taxes, miscellaneous itemized deductions)
• Include AMT preference items (tax-exempt interest from private activity bonds, excess intangible drilling costs)
• Subtract AMT exemption amount ($\$73,600 for single, \$114,600 for married filing jointly in 2021$)
• Apply AMT tax rates (26% on first $\$199,900$ of AMTI, 28% on AMTI above $\$199,900$ for 2021)
• Compare AMT liability to regular tax liability, pay higher amount

Strategies for AMT Minimization

Income and Deduction Timing

• Strategically time income and deductions across multiple years to avoid single-year AMT triggers
• Convert traditional IRAs to Roth IRAs in lower-income years (avoid increasing AMTI in high-income years)
• Evaluate tax-exempt municipal bonds without private activity designation (interest exempt from regular tax and AMT)
• Exercise incentive stock options (ISOs) over multiple years or with same-year sales to manage AMT exposure
• Maximize deductions allowed under both regular tax and AMT systems (charitable contributions)

Advanced AMT Planning

• Analyze state tax strategies (state taxes not deductible under AMT, consider low-tax state residence)
• Utilize AMT projection tools to model different scenarios and identify optimal tax strategies
• Consider AMT impact when making investment decisions (municipal bonds vs corporate bonds)
• Evaluate alternative minimum tax credit carryovers from previous years
• Explore opportunities to accelerate income in years with lower AMT exposure
• Consider the benefits of bunching itemized deductions in alternating years to minimize AMT impact