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ISOs: AMT



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In general, how does the alternative minimum tax (AMT) calculation work?
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 Calculation

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 currently a special exception that is effective through 2013). Even the standard deduction on Form 1040, 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.

Exemption Amounts

After AMTI is determined, it is reduced by an exemption amount. This AMT income exemption replaces the personal exemption and standard deduction from the regular-tax system.

  • The AMT income exemption amounts for tax year 2014 are $52,800 for single filers and $82,100 for married joint filers.
  • The AMT income exemption amounts for tax year 2013 are $51,900 for single filers and $80,800 for married joint filers.

Exemption Phaseouts

This AMTI exemption amount is phased out for high-income individuals by 25 cents for every dollar of AMTI over specified thresholds.

Tax year 2014: For married joint filers, the phaseout range starts at $156,500 of AMT income. For single filers, the phaseout starts at $117,300 of AMT income. The exemption is fully phased out (i.e. is zero) when AMTI is equal to or exceeds $484,900 for joint filers and $328,500 for single filers.

Tax year 2013: For married joint filers, the phaseout range starts at $153,900 of AMT income. For single filers, the phaseout starts at $115,400 of AMT income. The exemption is fully phased out when AMTI is equal to or exceeds $477,100 for joint filers and $323,000 for single filers.

AMT Rate

The net amount of AMTI is multiplied by the AMT rate to obtain the amount of AMT you owe.

  • For the tax year 2014, the AMT rate is 26% up to $182,500 of AMTI and 28% for greater amounts of AMTI.
  • For the tax year 2013, the AMT rate is 26% up to $179,500 and 28% for greater amounts of AMTI.
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.

Compare AMT With Regular Tax

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 is 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. The IRS has a basic AMT tool that can help you determine whether you may owe AMT.

Further Reading About The AMT

For guidelines on the likelihood of being hit with AMT, see a related FAQ. See another FAQ on methods for limiting and managing AMT. Other FAQs in the section ISOs: AMT Advanced explain various planning strategies.

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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