Don't Get Hit With an Alternative Minimum Tax Surprise | Adviser
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Don’t Get Hit With an Alternative Minimum Tax Surprise

When the Tax Cuts and Jobs Act expires in 2025, thousands of people could get hit by the Alternative Minimum Tax (AMT). Could you be one?

Manager of Financial Planning Andrew Busa defines the Alternative Minimum Tax, explains who’s currently impacted by AMTs—watch out if you’re about to exercise incentive stock options (ISOs)—and offers strategies to avoid the AMT surprise.

If you’re a fan of the Netflix show Stranger Things, then you’re familiar with the concept of the Upside Down. Congratulations! You’re already halfway to understanding how the AMT works. 

If that pop culture reference means nothing to you, here’s what you need to know: The AMT functions in a kind of parallel universe to the normal income tax, with different rates and methods of calculating income and deductions. People who fall into a specified income range must calculate both their normal income taxes and the AMT—and then pay whichever is higher. 

Under the current tax structure, those who may be affected by the AMT are:

  • Families and individuals with taxable income above $1 million with a significant amount of Schedule A deductions
  • Those who realize a large capital gain like selling a home
  • Those who exercise incentive stock options (or ISOs)

The Tax Policy Center reports that the number of taxpayers in the U.S. impacted by the AMT in 2018 was 200,000—but that number will almost certainly rise exponentially in 2025 if the Tax Cuts and Jobs Act (TCJA) expires as scheduled.

 

People who fall into a specified income range must calculate both their normal income taxes and the AMT—and then pay whichever is higher.
 
So, what can you do to mitigate your exposure to the AMT? 

 

Carefully consider your deductions. Pretax retirement plans (traditional IRAs, 401(k)s, 403(b)s, etc.) will reduce your total income—so stuff those retirement accounts!

Time your income. Accelerate or defer income (by selling stocks, taking your bonus or considering a Roth IRA conversion) to stack lowered income years when you anticipate a jump or drop the following year.

Be strategic with incentive stock options. Exercising ISOs does not impact your “regular” income tax, but it does affect your AMT calculation. Any AMT you pay from exercising an ISO is eligible for the AMT credit on Form 8801—and it could be a valuable lever you can pull to reduce income tax in future years. Keep in mind, however, you can only use the AMT credit for tax years when you are not paying it.

The AMT is an unfortunate reality you may find yourself trapped in. But our tax team can help you sort it out. If managed carefully, the AMT shouldn’t throw you off track for your financial goals.

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Video Transcript

Andrew Busa:

Hi, I’m Andrew Busa, Manager of Financial Planning with Today’s Adviser Takeaway.

Don’t get hit with an AMT surprise. The AMT, or Alternative Minimum Tax ensures that all taxpayers pay the minimum amount of tax. Now, in recent years, it’s been estimated that the number of people who are actually affected by AMT is only around 200,000, but that number is due to skyrocket at the end of 2025, when the Tax Cuts and Jobs Act expires.

Now under the current tax regime, here’s who is in the firing line potentially for AMT. It’s those with taxable income above $1 million with a significant amount of itemized deductions. It’s those who exercise an incentive stock option or ISOs. And finally, those who realize a large capital gain, such as selling a home.

So here are some ideas that we tell our clients to potentially avoid that AMT surprise:

Number one is to carefully consider your deductions. So those pretax retirement accounts are powerful here stuff those to lower your total income.

Number two is to time your income carefully, so accelerate or defer earnings to stack lower income years if you anticipate a jump or a drop in the following year.

And finally most importantly exercise those ISOs (incentive stock option) with care. Now, when you go to exercise an ISO, it has no impact on your regular tax but it does impact your AMT (Alternative Minimum Tax). Now, when you do pay AMT after exercising an ISO, you are eligible for an AMT credit and that’s a benefit to you because you can use that to offset a tax liability in a future year when you’re not paying AMT.

Now, AMT (Alternative Minimum Tax) sometimes is an unfortunate reality that our clients must deal with, but we’re here to help. Above all, it should not throw you off from your short, medium and long term financial goals. And that’s what you need to know about avoiding an AMT surprise. Thanks for watching!

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For informational purposes only; not a recommendation to buy, hold or sell any investment product. Past performance is not an indication of future returns. Speak with a financial advisor before taking specific action. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only and should not be construed as legal or tax advice. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. Always consult a professional regarding your specific situation.