How do you calculate the alternative minimum tax?
The alternative minimum tax (AMT) system is complicated. It 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. For each year, you are required to pay either your regular-tax liability or your AMT liability (whichever is greater).
Exercises of incentive stock options (ISOs) can trigger the AMT. This FAQ explains the AMT calculation. See also IRS Form 6251, Alternative Minimum Tax (Individuals), and its line-by-line instructions.
The AMT Calculation
Broadly, to your regular taxable income the AMT system makes certain negative and positive adjustments, such as the spread at ISO exercise, and applies tax items called AMT preferences. These are tax items that usually receive special treatment under the regular, non-AMT income tax rules. The resulting amount is your "alternative minimum taxable income" (AMTI). The standard deduction on Form 1040, if taken in lieu of itemizing, is not part of the AMTI calculation (you get a different AMTI exemption instead, as explained below).
Example: You have 1,000 ISOs with an exercise price of $10. You exercise and hold them when the market price is $50. You then hold the ISO stock through the calendar year of exercise. This results in an AMT adjustment of $40,000 ($40 spread x 1,000 options) that is part of your AMTI on Line 2i of Form 6251.
AMT Income Exemption
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 AMTI exemption amount is phased out for high-income individuals by 25 cents for every dollar of AMTI over specified thresholds. The Tax Cuts & Jobs Act ("tax reform") substantially increased these thresholds. The net amount of AMTI is multiplied by your AMT rate of 26% or 28% to obtain the amount of AMT you owe.
2023 AMT income exemption amounts, phaseouts, and rate thresholds
|Filer status in 2023||AMT income exemption amount||Exemption amount phaseout starts||Exemption amount phaseout ends||Point where rate
26% to 28%
(married filing separately: $110,350)
2022 AMT income exemption amounts, phaseouts, and rate thresholds
|Filer status in 2022||AMT income exemption amount||Exemption amount phaseout starts||Exemption amount phaseout ends||Point where rate
26% to 28%
(married filing separately: $103,050)
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 AMT income and regular taxable income are calculated. More of your income is taxable under the AMT, and compared to the current progressive tax rates under the regular tax system, the income starts getting taxed at a higher rate. In general, a rise in ordinary income rates but not AMT rates would reduce the likelihood of triggering the AMT, while a drop in ordinary income tax rates but not AMT rates would make triggering the AMT more probable.
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 To 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.
Essentially, you pay either your AMT amount or your regular-tax liability, whichever is larger. When you owe AMT, this number appears on Schedule 2 of your Form 1040 tax return. It becomes part of the Schedule 2 total that you report on Form 1040. For details of that, see ISOs: Tax-Return Tips And Traps.
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.
For a way to determine how many ISOs you can exercise and hold without triggering the AMT, see a related FAQ.
Remember Future Credit
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: You must calculate your AMT income (AMTI) and any taxes owed. Do not expect your employer to give you a form with AMTI on it. Your company will give you Form 3921 early in the year after exercise, and that form can help you calculate it.
IRS Occasionally Makes Mistakes
Lastly, be aware that (like taxpayers) the IRS sometimes makes mistakes. The US Treasury has reported that occasionally 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. Therefore, 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.
Further Resources On 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 articles and FAQs in the section ISOs: AMT Advanced explain various planning strategies.