High earners alert! Higher income means high taxes. Yeah, you can lower your tax bills through an itemized deduction. But you still have to pay the bare minimum AMT if your tax bill goes below the regular taxes. Here we have explained AMT and how you can work along with these tax systems to pay the minimum legally required. Also, we will provide expert tax tips to save more where applicable.
What is the Alternative Minimum Tax?
Congress introduced the Alternative Minimum Tax to ensure higher income earners don’t get through the loopholes of the tax system. For instance, a business applies for multiple credits and deductions, allowing it to pay near-zero taxes to the government. The AMT is designed to target these individuals and companies.
A Simple Breakdown of How the AMT Works
AMT is a shadow tax system. That means it goes parallel with regular taxes. If you are a high earner or have businesses, you should calculate both taxes to ensure you follow the IRS deadlines. We recommend getting help from professional tax accountants to ensure accuracy and compliance.
The Two Tax Systems:
AMT forces you to calculate your taxes twice. Once using the standard rules and once using the special AMT rules. Here is how both taxes are calculated:
- Regular Tax: It’s your standard calculation. You can expect credits and deductions at max! Resulting in regular tax liability.
- AMT Tax: A parallel calculation with fewer breaks. It comes with fewer tax breaks. It results in Tentative Minimum Taxes.
Key AMT Adjustments:
These are not just adjustments but actually traps for high-income individuals.
- State and Local Taxes (SALT) deductions: This is often the biggest trap. Under the AMT, the deduction for state and local income/property taxes is disallowed.
- Incentive Stock Options (ISOs) exercise: When you exercise an ISO, the difference between the exercise price and the market price is generally not taxed under regular rules but is considered income for the AMT calculation (phantom income).
- Large itemized deductions: Certain other itemized deductions (like miscellaneous or older medical expense deductions) were also disallowed or treated differently, though many of these were limited by the 2017 tax changes.
The Final Calculation:
According to the IRS, there is only one rule. You pay the higher of the regular tax or the AMT. Hire a professional tax preparer to calculate:
- Tax liability under the regular tax system
- Tax liability under the Tentative Minimum Tax system.
Simply put, the AMT ensures that if your tax breaks were so large. And your Tentative Minimum Tax (TMT) is greater than your Regular Tax, you pay the difference as the AMT.
Top 5 Ways to Strategically Reduce or Avoid AMT
- Time Your Deductions: If you expect to be hit by AMT this year, try to delay receiving certain incomes. You can also push deductible expenses like charities to next year.
- Manage Your ISOs: ISOs are the #1 AMT trap. Careful timing can help you avoid unexpected tax bills on unsold stocks. When buying or selling stocks, consult a pro first to be on the safer side.
- Rethink Property Tax Payments: Don’t prepay State and Local Taxes (SALT). The deduction is disallowed by the AMT anyway. Pay when these taxes are due. Prepay will do more harm if you are on the AMT threshold.
- Maximize Your Retirement Savings: Max out your retirement contributions. As contributions to traditional 401(k)s and IRAs reduce both regular and AMT income.
- Use the AMT Credit Wisely: Understand how to carry forward the Minimum Tax Credit to offset future regular tax liability.
Next Steps! Plan Your Income and Expenses Now to Save Later
Remember, AMT isn’t a tax bomb that falls on all your income. It only applies to amounts above the Alternative Minimum Tax exemption. Current exemptions are:
- Single / Head of Household: The exemption amount is $85,700.
- Married Filing Jointly: Expect an exemption of $133,300.
- Married Filing Separately: Each spouse is exempt for $66,650. The above will be considered taxable income.
If you expect to pay AMT, we recommend reviewing your prior year’s returns. You can consult our corporate or business tax experts for further advice.
Frequently Asked AMT Questions (FAQs)
Yes. It often catches high-income individuals living in high-tax states. It was initially designed for rich communities, but the upper-middle class may fall in the AMT bracket due to its strict rules. Also, high tax states like New Jersey, California and New York might be more affected by AMT.
No, but the exemption amounts are much higher now. For instance TCJA (Tax Cuts and Jobs Act) raised the exemption amount. However, many provisions of TCJA are scheduled to sunset after 31 December 2025.
For complex situations, a tax professional is highly recommended. You can call Tax King Service for the best advice and tax preparation services.
