The alternative minimum tax is a separate tax system that impacts high-earners.
Here's what it is, how it works, and ways it could impact you.
What Is Alternative Minimum Tax?
For starters, the Alternative Minimum Tax is exactly what it sounds like—a separate tax system designed to ensure high-earners pay their fair share (an alternative minimum as it were) of taxes if their regular tax bill is too low.
So how does it work?
AMT is an entirely different way to determine how much you owe in taxes. Essentially, you calculate your taxes under each system and pay whichever bill is higher. In some ways, AMT is a bit simpler. Instead of seven different tax brackets, there are just two: 26% and 28%.
Using tax prep software automatically calculates your tax bill according to each, so there’s no need to do anything differently. A tax professional will calculate the AMT when your income indicates you may be nearing the thresholds. If you file your own, you’ll need to fill out IRS Form 6251.
So what makes the AMT tax calculation different from your regular tax code?
The main differentiator is that AMT limits certain deductions and credits for high-earners. We will look at some specific examples later, but Form 6251 has a comprehensive review.
What Are The AMT Exemption Amounts for 2022?
Think of the AMT exemption as the “standard deduction” for the AMT calculation. Before applying the tax rate, you subtract this amount from your alternative minimum taxable income (AMTI).
For 2022, the AMT exemption amounts are $75,900 for single filers and $118,100 if you are married filing jointly.
The exemption is reduced by 25 cents for every dollar earned above $539,900. If your AMTI is $539,901, then your exemption is $75,899.75. The phaseout starts at $1,079,800 if you are married and file a joint return.
After subtracting the exemption amount from your AMTI, the 26% rate applies to income up to $206,100 for all taxpayers. The 28% rate applies to income above that amount.
What Tax Deductions Aren't Allowed Under The AMT Rules?
Certain deductions you may have been eligible for under the traditional system do not apply when calculating your income for AMT, including
- SALT taxes (including property tax)
- Personal exemptions
- Business items (For example, you have to add back any net operating losses from your Schedule 1.)
Even though you lose a lot of common exemptions, you can still deduct mortgage interest, donations to charity, and retirement plan contributions.
What Financial Moves Could Cause You To Pay The AMT?
Very few people actually pay AMT. However, that doesn’t mean you won’t, and you need to be mindful of what might trigger it, especially as a tech employee.
Some of the most common situations that cause you to have to pay AMT are:
- Realizing some long-term capital gains and dividends. These are taxed the same either way, but capital gains could push your income into AMT territory.
- Exercising ISOs. This situation most commonly applies to tech employees. Although you don’t owe any income tax on the bargain element until you sell, it is included in AMTI.
A common example here is you exercise a large number of shares, the share price is significantly higher than your strike price (i.e. a large bargain element), and you hold the shares beyond 12/31. The aggregate bargain element (# of shares x bargain element per share) is added to AMTI and excluded from the income in the regular tax calculation.
If you would like to know how many shares you could exercise and hold before you would be impacted by AMT, please contact us to run these calculations for you.
- You have a high salary. The whole point of the AMT is to make sure higher earners pay their fair share.
- Your state and local taxes (SALT) are high—these are added back to your income to calculate AMTI.
Tips To Lower Your Taxable Income
So, what if you have to pay the AMT?
First, understand that paying AMT doesn't mean disaster. Even if you end up paying AMT, you’ll have a credit you can use toward your regular income tax in a later year.
But, if you're looking to lessen your tax bill, you'll have to reduce your taxable income in ways that aren’t eliminated by the AMTI calculation. Here are a few ideas.
- Max out your retirement vehicles. If you have a 401k, you could knock off up to $20,500 from your income in 2022.
- Refine your charitable giving strategy. Giving can be an excellent piece of your financial plan as it allows you to support causes you care about and save a little in taxes along the way.
- Think strategically about your non-salary income. How will exercising stock options or realizing significant capital gains affect your AMT? When you have a choice, it may help to alter the timeline.
- Build a comprehensive tax plan with an advisor. Seeking outside advice can help bring continuity and structure to your plan.
If navigating the implications of AMT seems like a lot to think about, we’d love to help you.
At Rivermark, we work with many clients with tangible ISOs to help them balance the investment, cash flow, and tax dynamics of their company equity, including AMT estimates under various exercise scenarios.
Remember, there are no "one size fits all" answers here, but we can help you customize a plan that addresses your unique needs. Set up some time to connect with us today.