What High Earners Need to Know About the Alternative Minimum Tax (AMT)

If you’re a high earner, understanding how to navigate the Alternative Minimum Tax (AMT) is essential.

As you land promotions, receive substantial bonuses, or cash in on lucrative stock options, your financial circumstances can improve dramatically. However, for many high earners, financial success also comes with an increasingly complex tax situation.

Not only can your tax bracket change over time, but you may also be subject to taxes that you’ve never encountered before—taxes that can sneak up on you if you’re unaware of them. One common example is the Alternative Minimum Tax (AMT).

Congress originally established the AMT to target a small group of wealthy taxpayers who were benefiting from loopholes in the U.S. tax code. Yet the system has evolved into a complex maze that now affects a range of taxpayers, including employees with incentive stock options (ISOs).

In this blog article, we’ll explore the intricacies of the AMT—specifically, what it is, the factors that can trigger it, and the strategies you can leverage to minimize its impact on your financial plan.

What is the Alternative Minimum Tax (AMT)?

Congress created the Alternative Minimum Tax (AMT) system in 1969 to ensure that high-earning individuals and corporations pay a minimum amount of tax, even if they have numerous deductions, credits, or exemptions that would otherwise reduce their tax liability under the traditional income tax system. Taxpayers whose incomes exceed the AMT exemption must calculate their tax liability under both the traditional and AMT systems, paying the higher of the two amounts.

In 2023, households with incomes above the exemption amount ($81,300 for single filers and $126,500 for married couples filing jointly) may encounter the AMT. Meanwhile, AMT can also impact taxpayers with specific types of deductions or income, including:

• High levels of capital gains
• Foreign tax credits
• Passive income and losses
• Net operating loss deductions
• Profits from exercising Incentive Stock Options (ISOs)

Incentive Stock Options and AMT

One of the most lucrative benefits offered in the tech industry, startups, and other sectors is Incentive Stock Options (ISOs). ISOs provide employees with the right to buy company shares at a predetermined price, typically below market value.

Under the right circumstances, ISOs can offer a windfall of profits—at least on paper. However, simply exercising these stock options can activate AMT, potentially leading to a substantial tax liability.

For example, suppose your employer grants you ISOs that allow you to buy 1,000 shares at $20 each. The market value of these shares then skyrockets to $80. In an ideal scenario, exercising your ISOs would net you a paper profit of $60,000 ($80 market value – $20 exercise price) x 1,000 shares.

In the regular tax system, you wouldn’t have to recognize this profit at the point of exercise. Instead, you may be subject to the capital gains tax on any profits at the time of sale.

Under AMT rules, however, the IRS treats your $60,000 paper profit as income—whether you realize these gains or not. Depending on your overall income and potential deductions, this distinction can significantly increase your overall tax liability.

Managing the Impact of the Alternative Minimum Tax (AMT)

The first step in planning for AMT is understanding the circumstances that can trigger it. Additionally, the following tips and strategies may help you minimize AMT or avoid it altogether.

#1: Use Timing to Your Advantage

Strategically timing your income and deductions can help you manage AMT more effectively.

For example, if you anticipate falling into the AMT zone in a specific year—perhaps due to exercising ISOs or realizing a one-time capital gain—you might consider deferring other income sources to the following year. This may include deferring bonuses, postponing the sale of taxable assets, or delaying withdrawals from your retirement accounts.

Managing the timing of your deductions can also be helpful. Since many deductions allowed under the regular tax system aren’t allowed under AMT, you may want to time these deductions for years when you’re not subject to AMT, so you can manage the associated benefits.

#2: Strategically Manage Your Investments

For those with a sizable investment portfolio, high levels of capital gains can trigger AMT. If you’re already close to the AMT threshold, it may make sense to postpone realizing capital gains until a year when you expect lower income. Or you may be able to offset gains with capital losses, reducing your overall tax liability.

In addition, certain investments such as private activity municipal bonds generate “AMT income.” Keeping track of these details and managing them accordingly can help you minimize your tax burden.

#3: Utilize Tax-Deferred Accounts

Contributing the maximum amount to tax-deferred retirement accounts like an IRA or 401(k) can meaningfully lower your adjusted gross income (AGI), potentially allowing you to avoid triggering the AMT. In 2023, individuals can contribute up to $6,500 to an IRA and $22,500 to a 401(k) or similar plan. These amounts increase to $7,500 and $30,000, respectively, if you’re 50 or older.

In addition to providing immediate tax relief, maxing out contributions to tax-deferred retirement accounts in years when you aren’t subject to AMT may help you strategically plan for future years.

#4: Keep Track of Alternative Minimum Tax (AMT) Credits

If you’ve paid AMT in the past, you may have an unexpected windfall waiting for you—AMT credits that can be applied in future years. These credits help ensure that you’re not subject to double taxation on the same income over multiple years and can be particularly valuable for offsetting your regular tax liabilities.

AMT credits can carry forward indefinitely, offering a long-term strategy for tax optimization. However, maximizing the benefit of these credits often requires strategic planning, so it’s advisable to consult with a tax professional.

SageMint Wealth Can Help You Proactively Lower Your Tax Burden

The Alternative Minimum Tax may seem like an inevitable cost of being a high earner. However, with the right guidance and plan in tow, you can mitigate its impact and preserve more of your hard-earned income.

At SageMint Wealth, we can guide you through the intricacies of the AMT and help you proactively implement strategies to manage your overall tax burden. Together, we’ll develop a comprehensive plan that aligns with your circumstances and broader financial goals. Please contact us to begin your financial planning journey.

This information is not intended to be a substitute for specific individualized tax advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor.