What is Alternative Minimum Tax?
Under IRS rules, personal deductions and other tax benefits can significantly reduce a taxpayer's regular tax amount. However, the Alternative Minimum Tax (AMT) ensures that high-income taxpayers still pay a minimum amount of tax by limiting these benefits. The AMT has its own forms, rates, rules, and brackets, requiring you to calculate your federal income tax using this alternate system. Since the 2017 Tax Cuts and Jobs Act, some AMT brackets and thresholds are automatically adjusted for inflation.
Factors that can increase the likelihood of AMT
Certain deductions and types of income can influence whether or not you are subject to the AMT. Among the most common factors that can make an individual subject to the AMT include:
- High income
- State and local income taxes
- Interest on second mortgages and interest on home equity loans used for purposes other than home improvement
- Miscellaneous itemized deductions
- Medical expenses
- Exercising incentive stock options that were not sold
If one or more of the above factors apply to you, consider talking to your tax advisor to see if you may be able to reduce your exposure to AMT.
AMT and ISO Exercises
When you exercise an Incentive Stock Option (ISO), the difference between the exercise price (the price you pay for the stock) and the fair market value of the stock at the time of exercise is known as the spread. Typically this spread is not subject to regular income tax at the time of exercise, but it is included in your income for AMT purposes.
The inclusion of the spread in your AMT income can significantly increase your taxable income under the AMT system, potentially pushing you above the AMT exemption threshold. This can result in an AMT liability, even if you do not owe regular income tax on the exercise. The AMT calculation disallows many deductions and exemptions that are permitted under the regular tax system, leading to a potentially higher tax liability.
It's important to consider the potential AMT impact when planning to exercise ISOs, especially if the spread is substantial. Consulting with a tax advisor can help you navigate these complexities and develop strategies to manage or mitigate your AMT exposure.
How to determine if I am subject to AMT?
There are no guaranteed tests to determine in advance if you are subject to the AMT. If you were subject to it last year and you have a similar income and tax situation this year, you will most likely be subject to it again. To help determine if you are subject to AMT, the IRS provides guidance on how AMT is calculated, or you may wish to talk with a tax professional.
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Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
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