What Is the Alternative Minimum Tax?

United States tax code allows for numerous deductions, exemptions, and credits that can be used to reduce an individual's tax bill. However, some wealthy taxpayers were able to use their tax benefits to avoid paying much tax at all. To prevent this, Congress adopted a tax policy requiring high-income individuals to pay at least some tax. It created the Alternative Minimum Tax (AMT) to reduce the number of tax breaks high-earning taxpayers could claim.

Taxpayers subject to the AMT must calculate their regular income tax liability, then run the numbers again to determine their AMT liability. They must pay the higher of those two amounts. In other words, if you use tax breaks to lower your regular income tax liability past a certain point, the AMT establishes a higher tax liability you must pay. The amount by which the AMT exceeds your regular tax liability is known as the tentative minimum tax.

The calculations involved in finding out whether a taxpayer is subject to the AMT and the amount of tax they must pay are complicated. That's why even tax professionals usually use tax software to prepare the necessary IRS forms.

Alternative Rules for High Earners

The AMT tax rules differ from those of the normal tax system because there are alternative rules for calculating your taxable income and taxes owed. The AMT is intended to apply to high-income taxpayers and limits the benefits they can use to reduce the tax amount, including eliminating most tax deductions.

If you are subject to the AMT, you are no longer eligible to claim the standard deduction, the personal exemption, or these common itemized deductions:

• State and local tax payments, including real estate property taxes
• Medical expenses exceeding 7.5% of gross income
• Interest on home equity loans not used to pay for home improvements

Other differences between the AMT and the normal federal income tax include:

• Certain tax credits can't be claimed under the AMT.
• Some income exclusions aren't available under the AMT, such as the exclusion for income from private activity bonds.
• Many of the AMT rules for business depreciation and net operating losses are different from those for normal taxes.

U.S. taxpayers living abroad can use the foreign tax credit to offset their AMT liability on their tax return.

Incentive Stock Options

The AMT can significantly affect taxpayers who exercise incentive stock options (ISOs). That's because the gains on ISOs are usually not treated as ordinary income taxed at the normal income tax rate. Instead, they are taxed as capital gains at a maximum rate of 20%. However, if you are subject to the AMT, ISOs may be taxed at an up to 28% rate.

How the AMT Is Calculated

The AMT system is essentially a flat tax on adjusted gross income that exceeds a threshold known as the "AMT exemption." The AMT has two tax brackets — 26% and 28% — that apply to all income above the exempt amount.

Fortunately for those who might be subject to the tax, when Congress wrote the 2017 Tax Cuts and Jobs Act (TCJA), it increased the AMT exemption amounts for the 2018 through 2025 tax years. For 2023, the exemption amount is $81,300 for filers who are single or a head of household and $126,500 for married couples filing jointly. The amount of income that is tax-exempt is adjusted by the U.S. Treasury Department each year for inflation.

Taxpayers who are near or above the exemption threshold amount will likely need to run the numbers for both their AMT liability and the normal tax amount. The exemption amount is subtracted from their alternative minimum taxable income (AMTI), with the difference taxed at the appropriate tax rate. The AMT tax rate for 2023 is 26% for the first $220,700 of taxable income excess of the exemption amount for all taxpayers ($110,350 if married filing separately) and 28% for any amount over that.

Exemption Phase-Out

The AMT exemption will begin phasing out when you earn more than a specified amount in a year. For 2023, the exemption begins to phase out at 25 cents for each dollar earned when an individual's ATMI reaches $578,150. The level is $1,156,300 for those who are married filing jointly. Once the tax exemption has been completely phased out, all your income will be taxed at the 28% rate because you will no longer qualify for the exemption.

Questions About the AMT? Talk to an Attorney

If you think you may be subject to the AMT, you should speak to a local tax attorney who can help you assess whether you must pay the tax and help you with tax preparation. A skilled attorney understands tax law and can also help with tax planning to help you avoid being subject to the AMT in the future.