Understanding the Alternative Minimum Tax

Many taxpayers aren’t aware they’re subject to a little-known tax, called the alternative minimum tax or AMT, until they’ve slogged their way through lots of paperwork, or received an unexpected surprise during an IRS audit. The AMT can get complex quickly, so here’s what you need to know about the tax and your exposure to it.

Morgan Stanley and its affiliates do not provide tax advice. You should always contact your tax advisor for information specific to your situation.

What’s the Alternative Minimum Tax?

Originally enacted as part of the 1969 Tax Reform Act to prevent wealthy taxpayers from using loopholes to pay little to no taxes, today the AMT affects millions of middle class families it was never intended to target. Congress passed several measures to tie AMT exemptions to inflation. The Tax Cuts and Jobs Act of 2017 (TCJA) made additional modifications to the individual AMT that are intended to help lower income households avoid the tax.

Who Owes It?

The easiest way to understand AMT is to view it as a separate, parallel tax system, reducing some of the tax benefits higher income families use to lower their tax bills. The AMT also has its own set of deductions and different tax rates that, overall, are more onerous on the taxpayer.

Any taxpayer subject to regular federal taxes could potentially be subject to AMT. As a general rule, anyone with gross annual income above the applicable exemption amount who claims deductions for expenses or benefits from exclusions that are added back in the AMT calculation process should consider how this tax may potentially affect them.

How the Tax Works

The best way to determine if you owe the AMT is to fill out the regular tax form, as well as Form 6251, which essentially adds back certain deductions and exclusions to calculate the alternative minimum taxable income. You pay whichever bill is higher—your regular tax amount or your AMT amount. (The IRS offers an AMT Assistant online that tells taxpayers whether or not they need to pay the tax, but not the amount they owe.)

If you are subject to the AMT, you’ll see a big difference in what you can deduct. Many items that are deductible on a regular tax return are either not deductible through AMT or are treated differently, including:

• State, local, and property taxes

 

• Foreign tax credit

 

• Investment expenses

 

• Some medical and dental expenses

 

• Interest from some private-activity bonds

 

When calculating taxable income potentially subject to AMT, taxpayers are also required to include the spread between the market price and the exercise price of incentive stock options granted by their employer, when they exercise the options. 

Planning Ahead

It's difficult to avoid the tax altogether, but there are ways to potentially lower the burden.

For instance, though state, local and foreign taxes are not deductible under AMT rules, you can deduct the refunds, which are considered income under regular tax rules.

Also, if you are part of an equity compensation plan, you may be taxed on the spread on your incentive options upon exercise. As a result, the tax basis for the shares you bought is higher under the AMT. That means your tax bill may be lower when you sell the shares.

While the AMT takes away exemptions and many deductions, it does provide AMT-specific exemptions. The amount varies by filing status and starts to phase out once your income reaches a certain threshold. This means the higher your income, the higher your AMT tax rate.

In 2023, the alternative minimum tax exemption is $126,500 for married couples filing jointly and surviving spouses, $81,300 for single filers, and $63,250 for married couples filing separately. For 2023, the AMT exemption begins to phase out at 25 percent of excess AMT income over $1,156,300 for married filing jointly and surviving spouses. The phaseout begins at $578,150 for married couples filing separately and for single filers (not including surviving spouses). Since Congress changed AMT to adjust for inflation, the AMT exemption amount adjusts every year.

Finally, you may be able to claim your current year AMT payment on your tax return in future years. To find out if you qualify, complete IRS Form 8801.