How To Minimize Alternative Minimum Tax (AMT) Liability

In 1969, the United States Secretary of the Treasury gave testimony in which he informed Congress that those with an adjusted gross income of $200,000 or more had paid little to no tax. In today’s dollars, those incomes would be around $1.17 million. The public and congressional outrage that followed that piece of testimony inspired members of Congress to rethink certain parts of the tax system. Thus, the alternative minimum tax (AMT) was born. AMT is not the friendliest tax, however, and it has some serious limits in terms of deductions and flexibility. If the idea of having to pay AMT is hanging over your head, we’ll go over some steps you can take to minimize it.

AMT and how it works

The alternative minimum tax was structured as a parallel way to calculate taxes. This means that the calculation methods, deductions, and rates are different from those of the standard method of calculating taxes. You are exempt from AMT if your income is below the following threshold levels (for tax year 2023).

If your income is higher than this, you will subtract the exemption amount and calculate taxes based on the difference. When preparing your tax returns, you technically need to use both the AMT and the standard income tax return methods. You will then pay the higher of the two amounts owed.

The rate on AMTs will be either 26% or 28%. According to the Tax Foundation, “In 2023, the 28 percent AMT rate applies to excess AMTI (alternative minimum taxable income) of $220,700 for all taxpayers ($110,350 for married couples filing separate returns).”

Also note that the AMT will not have the same deductions that you might be used to if you have ever filed an income tax return using the standard method.

Ways to minimize AMT liability

You may not be able to avoid paying the AMT, but these actions can help you lessen your liability.

1. Avoid these red flags that trigger AMT

The current law lists some red flags that when triggered can force you into paying the AMT. These are:

• Claiming the standard deduction
• Exercising incentive stock options
• Larger capital gains
• Private activity bonds
• Depreciation
• Passive losses
• Business losses
• Property taxes
• State and local taxes
• Mortgage interest rated to specific types of home equity loans
• Unreimbursed business expenses deducted on Schedule A
• Professional fee deducted on Schedule A (legal/investment included)

Any of the items above, as well as issues associated with them, can be considered red flags by the IRS which trigger AMT.

2. Lessen gross income

One of the most straightforward ways to minimize the possibility of having to pay AMT is to lessen your gross income. Remember, the threshold is calculated on your adjusted gross income; thus, the less gross income you have, the less liability you have to pay AMT. Here are some kosher ways to do this under AMT rules:

Use your retirement accounts

With a traditional 401k, 403b, or IRA plan, the income is not taxed upon investment but is instead taxed as ordinary income when withdrawn. Therefore, you can lessen your overall gross income that would be subject to AMT. On the flip side, if you have a Roth structure, you might not be able to lessen your tax burden up front, but you could lessen it during your retirement years. Roth withdrawals are not taxed and, thus, will not be included in the AMT calculations.

Donate money to charity

Donating to charity is another way to minimize AMT for income taxes and capital gains. Any portion of income donated to charity receives 100% in tax credits and is not subject to capital gains tax. This is a great way for high-income earners who have a lot of stockholders to avoid capital gains by donating the securities to charity. However, this might not always be the case. Congress is looking at taxing 30% of any capital gains that would arise from donations of publicly listed securities to charities, as well as reducing income tax credits by 50%.

Restructure your income

A solid plan, if you can do it, is to restructure your income to be less liable for AMT. Two ways to do this are:

• Defer payment. If you don’t need the money and can defer payment in any form to a more favorable time frame, like another tax year, this can help.
• Turn salary into expenses. If you use your salary to pay for work-related items and do not claim it properly, consider restructuring your contract so that part of your salary is an expense account. Business-related expenses that you claim via an expense account will not be included in the AMT calculations.

3. Be smart about exercising stock options

Many high-income earners have employment contracts that include their salary as well as bonuses and incentive stock options, or ISOs. Exercising ISOs will trigger AMT, unlike standard ISOs, which are typically taxed favorably as they are subject to “qualifying disposition.” This means favorable tax treatment in layman’s terms. If ISOs are part of your overall compensation package, you might want to consider:

Exercise ISOs at the beginning of the calendar year

If you exercise your stock options at the beginning of the year, then you have a whole year to track the price. You then can decide, based on the stock’s movement, if you should sell in a “disqualifying disposition.” Capital gains are taxed in a qualifying disposition only if they are held for at least one year.

Exercise options at the right time, with a low spread

Remember, large capital gains are considered red flags for triggering the AMT. Thus, you might want to consider exercising these options when the stock option price is close to the market’s fair value. Kendall Meade, a financial advisor with SoFi, says that the difference between the price you pay and the stock’s fair market value at exercise is subject to AMT.

“You will want to decide the best time to exercise and the best time to sell while taking into account long-term vs. short-term capital gains, AMT taxes, and how the value of the stock may fluctuate during those periods. This can get very complicated, so it is important to work with a financial planner and an accountant to create a strategy to manage AMT taxes,” she says.

4. Invest in securities considered tax efficient, like municipal bonds

One way to minimize AMT is to invest in tax-efficient securities such as municipal bonds. Local governments and municipalities typically issue municipal bonds to fund specific projects. The money derived from the bonds is generally exempt from federal taxes as well as the taxes in the state where you live if the municipal bond was issued from that state.

In fact, municipal bonds have become such a popular way to minimize AMT liability that some advertise themselves as “AMT-free.” However, it’s important to note that a municipal bond is not always free from AMT; it depends on the project.

5. Be aware of the phaseout threshold

You should always be aware of the current phaseout threshold for AMT. This basically means that once you reach the threshold, you are charged $.25 for every dollar that is above the threshold. Below are the phaseout thresholds for the tax year 2023.

Get help with your taxes

Not sure if you will be subject to the AMT? A tax professional can help you make sense of the numbers. Compare your options below.

FAQ

How to minimize AMT on ISO?

One of the best ways is to exercise incentive stock options at the beginning of the year. This gives you the whole year to decide if you want to sell before you qualify for a “qualifying disposition.” Another trick is to wait until the spread is low between your options and FMV to exercise the options. As this would not be a very big capital gain on paper, it won’t set off any red flag alarms.

What would trigger an AMT?

Large capital gains and private activity bonds are just some of the actions that can trigger AMT. It’s best to review the list at the top of this article and take heed.

What are adjustments for AMT?

Adjustments for AMT are the differences in deductions and tax treatment between standard tax filing and AMT tax filing. For instance, state and local property taxes can be deducted from a standard filing. However, they must be added back when calculating AMT; therefore, the taxable income method is “adjusted.”