The purpose behind the alternative minimum tax system, otherwise known as AMT, is to ensure that all taxpayers, particularly high-income taxpayers, pay a minimum amount of federal income tax. Implemented in the later part of the 1960s to ensure all taxpayers pay their fair share. If your adjusted gross income (AGI) exceeds the AMT exemption level, you may be required to pay the alternative minimum tax. This will impose a minimum tax on taxpayers who have substantially lowered their regular tax liability by taking advantage of tax preference items including deductions, exemptions, and credits. Fortunately, there are planning opportunities available for high-income taxpayers to avoid being subject to AMT.
The alternative minimum tax applies to higher-income individuals, as well as to trusts and estates. AMT is a separate tax system that runs parallel with the regular tax system. It is the excess of the tentative minimum tax over the regular tax and AMT is owed only if the tentative minimum tax is greater than the regular tax.
Alternative Minimum Tax Thresholds
The AMT primarily affects individuals with higher incomes. It increases the amount of income that is taxable and taxes it at a higher rate. AMT adds items that are not taxed on the standard tax system and removes or reduces many common tax breaks used by individual taxpayers to lower their liability.
The 2023 AMT exemption threshold is $81,300 and begins to phase out at $578,150 for single filers or heads of household. For married couples filing jointly, the threshold begins at $126,500 and phases out at $1,156,300. However, exceeding these minimum income levels does not automatically trigger AMT. To determine if you qualify for AMT exemption, you will need to complete Form 6251 (for individuals), Form 1041 Schedule I (for estates and trusts), or consult a tax professional.
In 2023, if your income falls within the threshold amounts and you trigger the AMT, your tax rate will be 26%. If your income exceeds the phase-out amount, your AMT tax rate will increase to 28%. However, if your regular tax rate is above 28% you will pay a higher regular tax rate on your taxable income.
What Increases Your Likelihood of Being Subject to the Alternative Minimum Tax?
Income Over the AMT Threshold
The first and most obvious answer is high income. Incomes above the AMT threshold are likely to trigger AMT. However, this is not the only qualification that needs to be met.
Large Itemized Deductions
If you have substantial itemized deductions, particularly in disallowed or limited categories, your chance of triggering the AMT increases.
Large Capital Gains
Substantial capital gains from the sale of stocks, real estate, or other investments can trigger the AMT.
Tax Preference Items
The AMT adds back certain tax preference items into the calculation, such as the exercise of incentive stock options, excess depletion deductions, and certain tax-exempt interest.
Certain Business Deductions
The AMT disallows certain business deductions, such as certain research and development expenses, that are allowed under regular tax rules.
Tax Planning Options to Reduce the Likelihood of Being Subject to AMT
Individuals subject to the AMT commonly benefit by timing their tax items, deferring certain items, and accelerating others. It is best to accelerate items of income into AMT years and postpone deductions into non-AMT years. Various strategies for reducing AMT liability include:
- delaying payment of tax preference items, such as state and local income taxes, property taxes, medical expenses,
- timing capital gains to lower income years
- increase charitable contributions,
- avoiding the exercise of incentive stock options in the year in which a taxpayer is subject to the AMT,
- Increase contributions to your 401K plan,
- Increase cafeteria plan participation.
The best way to handle AMT liability is careful planning involving the coordination of future regular income tax and AMT, using accurate projections of income, expenses, and deductions over multiple years with several alternative scenarios. An overall plan must then be devised to manage your AMT liability without raising regular tax liability. As you can see, there are many strategies to reduce your likelihood of being subject to AMT. Please note that the AMT rules are complex and can change over time. It’s important to consult with a qualified tax professional to accurately assess your potential AMT liability based on your specific financial situation.