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The AMT system requires you first to compute your tax liability as you normally would by completing your IRS Form 1040 tax return. Then you separately recompute your taxes under the AMT system by following its special rules. (See IRS Form 6251, Alternative Minimum Tax (Individuals), and its line-by-line instructions.) For each year, you are required to pay either your regular-tax liability or your AMT liability (whichever is greater).
The AMT system is complicated. Broadly, it starts by taking your adjusted gross income, subtracts your itemized deductions, makes certain negative and positive adjustments, and includes certain tax items called tax "preferences." The resulting amount is your "alternative minimum taxable income" (AMTI). An example of a tax preference added to AMTI is the exclusion from income of a portion of the gain from the sale of "qualified small business stock" held for more than five years (though there is a special exception to this effective only for part of 2010 and all of 2011). Even the standard deduction, if taken in lieu of itemizing, is not part of the AMTI calculation.
Examples of positive adjustments include itemized deductions for state and local income taxes, real and personal property taxes, and miscellaneous itemized deductions. This is why people living where state and local taxes are high (e.g. California, New York, Massachusetts) are more likely to trigger the AMT. The spread at exercise of an ISO is also a positive adjustment when you continue to hold the ISO stock through the calendar year of exercise.
Example: You have 1,000 ISOs with an exercise price of $10. You exercise and hold them when the market price is $50. You have an AMT adjustment of $40,000 ($40 spread x 1,000 options) that is part of your AMTI on Line 14 of Form 6251.
After AMTI is determined, it is reduced by an exemption amount. This AMT exemption replaces the personal exemption and standard deduction from the regular-tax system. The temporary AMT income exemption amounts for 2011 were $74,450 for married joint filers and $48,450 for single filers. (The AMTI exemption amounts for 2012 have not yet been determined and will probably not be set until late in the year, after the presidential election.)
This AMTI exemption amount is phased out for high-income individuals by 25 cents for every dollar of AMTI over specified thresholds. For joint filers, this phaseout range starts at $150,000 of AMT income; for single filers, the phaseout starts at $112,500. For the tax year 2011, the exemption was fully phased out (i.e. was zero) when AMTI was equal to or exceeded $447,801 for joint filers and $302,301 for single filers.
The net amount of AMTI is multiplied by the AMT rate (26% up to $175,000 AMTI, 28% for AMTI amounts above $175,000) to obtain the amount of AMT you owe.
Alert: Don't be fooled if the AMT rates (26% and 28%) are lower than the rates of your regular tax bracket. Your AMT taxable income is often much higher because of the differences in how AMTI and regular taxable income are calculated. In general, rising rates of ordinary income tax without rising AMT rates reduces the probability that you will be snared by the AMT.
Your effective AMT rate is higher if your exemption amount is phased out. The calculations are further complicated if you had any capital gains during the year, because capital gains are taxed at 15% under AMT, not 26% or 28%. Your AMT liability can be offset by any nonrefundable personal credits, such as the HOPE and Lifetime learning education credits and the adoption, child, and saver's credits.
Finally, you compare your AMT liability with your regular-tax liability. Your regular-tax liability is the amount of taxes that you tentatively owed when you computed your federal income taxes on IRS Form 1040 without regard to AMT, reduced for any taxes that you owe for premature-retirement-plan distributions under IRS Form 4972 and by the amount of any foreign tax credit that you took on your Form 1040.
It's commonly said that you pay either your AMT amount or your regular-tax liability, whichever is larger. Technically, after you have completed Form 6251, the amount by which your AMT exceeds your regular tax is then added on Line 45 of your Form 1040 (Form 6251 becomes an attachment to it).
Example: Regular income tax is $55,000. Your AMT is $75,000. You pay $20,000 of AMT, along with $55,000 of regular income tax. In many cases, the extra AMT beyond your regular-tax liability for your ISO exercise/hold may be recovered in later years through a tax credit. Don't forget that the sale of your ISO stock affects AMT liability in the year of the sale (see a related FAQ). These AMT and ISO topics are discussed in the section on ISOs.
Alert: Do not expect your employer to give you a form with AMT income (AMTI) on it. You must calculate it and any taxes owed.
For guidelines on the likelihood of being hit with AMT, see a related FAQ. See another FAQ on methods for limiting and managing AMT.
Note that ISO exercises in California are also part of the state AMT calculation (see Schedule P).
IRS Makes Mistakes Too
Lastly, be aware that (like taxpayers) the IRS sometimes makes mistakes. The US Treasury reported in July 2008 that some IRS examiners have made procedural errors when reviewing AMT returns that the IRS computers flagged for discrepancies. Some of these mistakes resulted in an incorrect computation of AMT. The Treasury reports that it will focus on AMT procedures in annual training of IRS staff. However, if the IRS reports a discrepancy in your return and produces a different computation of AMT, you may still want your tax advisor to run the numbers again to double-check the IRS result. |
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