How the New Tax Law Changes the Alternative Minimum Tax


There is one change under the Tax Cuts and Jobs Act that almost everyone can agree is a big improvement: the scope of the alternative minimum tax has been considerably reduced.

Thanks to adjustments to the AMT exemption rules, combined with tough new caps on common deductions, the number of taxpayers expected to be subject to the AMT on their 2018 tax returns is 200,000, up from 5 .2 million in 2017, according to the Center for Tax Policy.

Most of those still affected by the AMT will be employees who will receive incentive stock options as part of their compensation, says Greg Horning, director of SC&H Group, a management consultancy, audit and tax in Sparks, Maryland. have a hard time finding someone else – they should have a confluence of pretty big tax adjustments,” he says.

How AMT Works

The AMT is a separate tax regime intended to prevent taxpayers who claim numerous deductions and exemptions from avoiding their fair share of taxes. It was designed in 1969 after the Internal Revenue Service noticed that a number of wealthy people paid no income tax.

Read more: How the new tax law will affect you and how to lower your bill next year

The IRS requires taxpayers to calculate their tax bills under both the income tax system and the AMT, and pay tax whichever produces the higher tax bill . The top tax rate of 28% is lower than the top tax rate of 37%, but if you are subject to AMT, you lose the benefit of most major deductions and end up paying more of taxes.

Over the years, the AMT began to affect taxpayers lower and lower on the income scale, as the AMT exemptions and income thresholds were not updated with the inflation adjustments of the income tax brackets.

According to Tim Steffen, director of advanced planning at Baird Private Wealth Management, most couples filing jointly with two children and earning between $200,000 and $700,000 a year would be subject to the AMT. “Now AMT is now much closer to its original intent,” Steffen says.

The new tax law changes to the AMT, and who is still affected

The AMT exemption for couples filing joint tax returns has increased from $86,200 to $109,400. For singles, it goes from $55,400 to $70,300. The exemption begins to phase out for couples with an income of $1 million, compared to $164,100 under the old law. Singles begin to lose the exemption when income exceeds $500,000, down from $123,100 previously.

Even for people whose income exceeds the elimination thresholds, deductions are unlikely to trigger AMT because they have been capped under the new law. Taxpayers can claim up to just $10,000 in combined state and local property and income taxes. And mortgage interest deductions can only be claimed on mortgages up to $750,000 under the new rules, up from $1 million previously.

So, who could still get slammed with the AMT?

Employees who receive incentive stock options are the biggest group at risk, Horning says.

Read more: 6 ways to avoid a big surprise tax bill

These options are a common form of compensation that allows employees to purchase their company’s stock in the future at the stock price at the time the option was granted. If you are granted options today when your company’s stock is priced at $20 per share, you have the option of buying the stock or exercising the option in the future for $20, regardless regardless of the rise in the stock price.

The catch, from a tax point of view, is that the difference between the exercise price and the actual price of the stock when it was purchased should be considered as income in the calculation of the AMT, but not for ordinary income tax. So when determining whether you owe more under the regular income tax system or AMT, this discrepancy on your options might be enough to push you towards AMT.

Minimize your AMT load

Taxpayers may be able to minimize the AMT bite with multi-year planning. “They can exercise a little each year so that they come under the AMT exemption amounts,” says Mary Russell, an attorney and founder of Stock Option Counsel in Palo Alto, Calif.

Keep in mind, however, that options generally must be exercised within a specified time frame, typically after a three-year vesting period and within 10 years.

To have the flexibility to avoid a future big AMT hit, it may be a good idea to exercise options early — before vesting — if you can, says Russell. Some compensation contracts allow this, allowing employees to eliminate or minimize the difference between the exercise price and the fair market value of the company’s shares. Employees who negotiate terms can request the opportunity to exercise early, she said.

There’s another time frame to keep in mind: the AMT changes, along with most of the changes made by the new tax law, expire in 2025 and revert to the 2017 rules.

Taxpayers will need to consider whether it makes sense to accelerate the exercise of their options before 2025. This will depend on a host of personal details ranging from income level and the size of other deductions to the amount and potential value options.

Folks on the cusp of AMT should be wary of a few other factors that could push them into the tax system.

Consider private activity municipal bonds, which are issued by governments to raise funds for private projects for public use, such as airports or stadiums. Interest on these is tax-free for regular income tax purposes, but taxable under AMT.

“If you’re just barely out of the AMT, the interest in those bonds might push you,” Steffen says.

The same is true for oil and gas investors and people claiming accelerated capital cost allowances on rental properties or flow-through entities. Net income from oil and gas investments must be taken into account for AMT purposes, as must capital cost allowances.

None of these factors alone will most likely pose an AMT risk. But taken together, or coupled with the exercise of incentive stock options, the AMT could still pack an unwanted punch.


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