The alternative minimum tax (AMT) is a parallel tax system with fewer deductions but lower tax rates than the regular income tax system. It is a parallel tax system in the sense that taxpayers must calculate their tax liability under both the AMT system and the regular tax system and pay whichever liability is higher.
I will help small business owners understand the basics of the AMT and what situations might trigger an AMT liability. However, there are far too many nuances and complications to adequately cover in an article, and I don’t advise dealing with AMT on your own.
Are you not calculating your AMT? Don’t worry. If you use quality tax software to prepare your return, the software will check for AMT. If you’d like to see the calculation, force Form 6251 to print. Visit our best small business accounting software to see our top choices.
Alternative Minimum Taxes for Small Businesses
AMT applies to individuals, but C corporations (C-corps) are no longer subject to the AMT rules. All individual taxpayers—including owners of Schedule C businesses, S corporations (S-corps), and partnerships—should calculate their tentative minimum tax each year.
Flow-through entities, such as S-corps, partnerships, and some limited liability companies (LLCs), do not calculate AMT on their own tax returns. Instead, they track any AMT adjustments and preferences and pass them through to their owners on Schedule K-1. The owners combine the flow-through AMT items with their personal AMT adjustments and preferences to calculate any AMT liability.
Most Common AMT Causes
One of the most important things business owners can understand about the AMT is when it might be triggered. These triggers are not exact and inclusive of every situation but should give you an idea of when to be concerned:
- Exercise of incentive stock options (ISOs): ISOs allow you to purchase stock for a price below fair market value (FMV). For regular taxes, the exercise of ISOs by purchasing stock at a discount does not produce taxable income. However, you must increase alternative minimum taxable income (AMTI) by the excess of the FMV of shares you acquired over the price you paid. Since AMTI has been adjusted upward compared to regular taxable income, you are more likely to owe AMT.
In my experience, it is very likely you’ll owe AMT if you exercise ISOs. Please seek the advice of a tax pro before you exercise the options. There is planning they can do to help minimize the AMT in the current year and to recover the AMT in a later year through the minimum tax credit (discussed below).
- Income over $1 million with a high portion of long-term capital gains: When income is over a million, the AMT exemption phase-out becomes a concern. If most of the income is ordinary, then it is taxed at much higher rates for AMT than for regular tax—and AMT is not a concern. However, if most of the income is capital gain, it is taxed at the same rate for both AMT and regular tax. Therefore, the loss of the exemption is likely to cause AMT.
- Adjusted gross income (AGI) over $125,000 with very low taxable income: This depends upon why taxable income is low. If AGI was reduced with deductions not allowed for AMT, then an AMT is likely to exist.
If you think you might fall into one of the situations listed, I advise you to talk to a tax professional.
Alternative Minimum Tax Formula & Terms
While the AMT and regular tax systems are considered parallel systems, in practice, the AMT is calculated by starting with regular taxable income and making adjustments for differences between the systems. Here is the AMT formula, and we discuss the terms in the formula below:
Regular taxable income
+ AMT preferences and exclusions
+/– AMT adjustments
= Alternative minimum taxable income
– AMT exemption
= Tentative minimum tax base
× AMT rate
= Tentative minimum tax
– Regular tax
= Alternative minimum tax
What are AMT Preferences & Exclusions?
AMT preferences and exclusions are permanent differences between the regular tax and minimum tax. A major exclusion for many taxpayers is their standard deduction, and the standard deduction allowed to individuals for regular taxes is not allowed for tentative minimum tax, so it must be added back.
Here is a partial list of common preferences and exclusions that must be added back to regular taxable income to calculate AMT:
- Standard deduction
- Private activity bond interest
- Depletion deduction
- Intangible drilling costs
If any of these items are incurred by a partnership or S-corp, they are reported on the Schedule K-1 provided to the owners. The owners then carry the AMT preferences and exclusions reported on Schedule K-1 to their individual AMT calculation.
What are AMT Adjustments?
AMT adjustments are either temporary or permanent differences between regular tax and minimum tax and can be either a positive or negative adjustment.
For example, depreciation is calculated differently for regular tax and minimum tax purposes. In some years, regular depreciation is higher than AMT depreciation, so there is a positive adjustment. In other years, regular depreciation might be less than AMT depreciation and there is a negative adjustment.
Because AMT depreciation adjustments reverse over the depreciable life of an asset, they are called temporary adjustments. Here is a partial list of common temporary AMT adjustments:
- ISOs: The exercise of ISOs create a positive adjustment in the year of exercise and a negative adjustment in the year the stock acquired with the ISO is subsequently sold.
- Depreciation: Depreciation generally results in a positive adjustment early in the life of the asset and negative asset in the later years.
- Gain/loss on the sale of depreciable assets: Since depreciation is different for AMT and regular purposes, the gain or loss when you sell a depreciable asset is different. This adjustment is generally negative and a reversal of the positive depreciation adjustment taken in an asset’s early life.
Some AMT adjustments are permanent. The most common permanent AMT adjustment is the add-back of state and local taxes. While this used to be a major adjustment, now that state and local taxes are limited to $10,000 on Schedule A, the maximum add-back is also only $10,000.
AMT Exemptions for 2023 & 2024
Most taxpayers can reduce their AMTI by an exemption amount based on their filing status, regardless of whether they deduct any itemized deductions.
Filing Status | 2023 AMT Exemption | 2024 AMT Exemption |
|---|---|---|
Married Filing Jointly | $126,500 | $133,300 |
Single or Head of Household | $81,300 | $85,700 |
Married Filing Separate | $63,250 | $66,650 |
However, the AMT exemption is phased out for high-income taxpayers. The AMT Exemption is reduced by 25% of the amount of your AMTI over the threshold.
Filing Status | 2023 AMT Exemption Phase-Out Begins | 2023 AMT Exemption Is Completely Phased Out |
|---|---|---|
Married Filing Jointly | $1,156,300 | $1,662,300 |
Single, Head of Household, or Married Filing Separate | $578,150 | $903,350 |
Married Filing Separate | $578,150 | $831,150 |
Filing Status | 2024 AMT Exemption Phase-Out Begins | 2024 AMT Exemption Is Completely Phased Out |
|---|---|---|
Married Filing Jointly | $1,218,700 | $1,751,900 |
Single, Head of Household, or Married Filing Separate | $609,350 | $952,150 |
Married Filing Separate | $609,350 | $875,950 |
Assume a Married Filing Joint taxpayer in 2023 has AMTI prior to the exemption of $1.5 million. Their AMT exemption must be reduced by $85,925 ($1,500,000 less $1,156,300 times 25%.) Their remaining deductible AMT exemption is $40,575 ($126,500 less $85,925).
AMT Rates
The AMT is nearly a flat tax—it has only two rates: 26% and 28%. AMTI below the threshold is taxed at 26%, and AMTI above the threshold is taxed at 28%. The threshold for the increase in tax rate depends upon your filing status.
Filing Status | 28% Tax Rate Begins at AMTI of (2023) | 28% Tax Rate Begins at AMTI of (2024) |
|---|---|---|
Married Filing Jointly, Single, or Head of Household | $220,700 | $232,600 |
Married Filing Separate | $110,350 | $116,300 |
AMT Capital Gains Rate
Capital gains are taxed for AMT at the same rate as they are taxed in your regular tax liability computation. However, they are still included in AMTI and can force other income into the higher 28% tax bracket and cause your AMT exemption to decrease.
As discussed in more detail in the section on common AMT triggers, even though capital gains are not taxed at the normal AMT rate, capital gains large enough to reduce the AMT exemption are likely to trigger an AMT liability.
Assume a Single taxpayer in 2023 has AMTI of $250,000. They calculate tax on the first $220,700 at 26%, for a tax of $57,382. The $29,300 of AMTI that exceeds $220,700 is taxed at 28% for a tax of $8,204. So, the total tentative minimum tax liability is $65,586.
Tentative Minimum Tax vs Alternative Minimum Tax
As discussed above, taxpayers must calculate their taxes under two parallel systems: the regular tax system and the AMT system. The total tax liability under the minimum tax system is referred to as the Tentative Minimum Tax. If it is greater than the regular tax, then the excess is the AMT. If the tentative minimum tax is less than the regular tax, then the AMT is zero. However, AMT cannot be less than zero.
Alternative minimum tax = Tentative minimum tax – Regular tax
The AMT is just a “plug” figure to increase the regular tax up to the tentative minimum tax liability. If you’re paying AMT, then reducing your regular tax liability—without reducing your tentative tax liability—results in more AMT and your total tax liability stays the same. If you’re paying AMT, then it’s important to understand what is deductible for your tentative tax liability as that is the only way to reduce your total tax liability.
What Is the Minimum Tax Credit?
A minimum tax credit is created when AMT is paid—but only if the AMT is the result of temporary AMT adjustments. If your AMT was caused by preferences or permanent adjustment, you don’t get the benefit of minimum tax credit.
The minimum tax credit, which is necessary for fairness, can be used to reduce your regular tax liability down to your tentative minimum tax liability. Without the minimum tax credit, you wouldn’t get the benefit of your temporary AMT adjustment reversing in the future.
Pat exercises incentive stock options in 2023 that result in the following taxes:
2023 | |
Regular Tax | $50,000 |
Alternative Minimum Tax | $10,000 |
Tentative Minimum Tax | $60,000 |
Since the AMT was created by a temporary difference (the ISOs), Pat receives a minimum tax credit of $10,000 that can be carried forward to future years.
Now, say that in 2025, Pat sells the stock acquired in the ISO. The positive adjustment made in 2023 now reverses and there is a large negative adjustment in 2025. Let’s assume the negative adjustment results in a tentative minimum tax that is $10,000 less than the regular tax. Pat can use their $10,000 minimum tax credit to reduce their 2025 tax liability down to the amount of their tentative minimum tax.
2025 | |
Regular Tax | $50,000 |
Minimum Tax Credit | -$10,000 |
Tentative Minimum Tax | $40,000 |
Without the minimum tax credit rules, Pat would never have recovered the extra $10,000 tax paid in 2023, even though the adjustment for ISOs is only temporary. While things in the real world never work out quite this neatly, this explains the gist of the minimum tax credit and why it is important.
Frequently Asked Questions (FAQs)
The AMT was created to address a perceived problem that high-income taxpayers were avoiding paying any tax by having a large amount of deductions. The AMT creates a parallel tax system where many of these deductions are removed and a lower tax rate applied.
All individual taxpayers are potentially liable for AMT, but very few individuals owe anything. The most common reasons for having to pay AMT are the exercise of incentive stock options or the incurring large long-term capital gains.
Bottom Line
Small business owners might be subject to the AMT on their individual returns. While the AMT adjustments flowing through to their individual return from their small business on Schedule K-1 will certainly affect the liability, the adjustments are generally not enough by themselves to create an AMT liability. The most common triggers for an AMT liability are the exercise of ISOs and long-term capital gains.
