As a high-income earner, you may have breathed a sigh of relief when the Tax Cuts and Jobs Act (TCJA) of 2017 reduced the impact of the alternative minimum tax (AMT). However, the AMT will return in full force after 2025, when key TCJA provisions expire.
Under the AMT, certain taxpayers must calculate their tax liability twice—once under the regular income tax rules and again under the AMT rules. You then pay whichever amount is higher. The AMT has its own set of tax rates (26% and 28%) and allows fewer deductions compared with the regular tax system, ensuring that high-income earners pay a minimum amount of tax regardless of their deductions.
Before the TCJA, the AMT affected a significant number of high-income households. But the TCJA’s higher exemptions and increased phaseout thresholds shielded most taxpayers from the AMT’s reach. According to data from the Tax Policy Center,1 in 2022 only 0.1% of households overall and 2.1% of those with incomes between $500,000 and $1 million were subject to the AMT. However, unless Congress acts before the TCJA expires on Dec. 31, 2025, the rules around AMT could revert to the pre-TCJA form. This could mean many more taxpayers will be forced to pay AMT in 2026 and beyond. All this may increase taxes among one-fifth of taxpayers in the $200,000 to $500,000 range and among 70% of those with incomes between $500,000 and $1 million.2
| AMT exemptions | |||
|---|---|---|---|
| Type of taxpayer | Pre-TCJA (2017) exemption3 | 2024 TCJA exemption4 | Change in exemption |
| Single filer | $54,300 | $85,700 | $31,400 |
| Married filing jointly or qualifying widow(er) | $84,500 | $133,300 | $48,800 |
| Married filing separately | $42,250 | $66,650 | $24,400 |
| Income at which exemption starts to phase out | |||
|---|---|---|---|
| Type of taxpayer | Pre-TCJA (2017) phaseout5 | 2024 phaseout6 | Change in phaseout |
| Single filer | $120,700 | $609,350 | $488,650 |
| Married filing jointly or qualifying widow(er) | $160,900 | $1,218,700 | $1,057,800 |
| Married filing separately | $80,450 | $609,350 | $528,900 |
Personal tax rates are probably going in one direction: Up.
As we look ahead to the post-TCJA tax code, remember that proactive tax planning with your wealth advisor can help mitigate the impact of this often surprising tax. Don’t let the AMT catch you off guard. Here’s what to know and how to prepare now for its potential return.
Evolution of the AMT
The AMT was introduced to address concerns that some high-income individuals were using various deductions and loopholes to reduce or even eliminate their tax liabilities. According to a Joint Economic Committee report on the matter, in 1969, a simpler version of the AMT called the “add-on minimum tax” was enacted. This was in response to the IRS finding that 155 taxpayers with incomes exceeding $200,000 had avoided paying any income tax in 1966 by leveraging deductions not available to the average taxpayer.7
The add-on minimum tax targeted specific income items that were lightly taxed or overlooked by the regular income tax system, with the most significant being the portion of capital gains excluded from regular taxation. Over the years, the AMT evolved and expanded its reach, affecting a growing number of taxpayers. By 2015, nearly 4.5 million individuals were subject to the AMT.
Recognizing that the AMT’s reach had expanded far beyond its original intent, Congress included provisions in the TCJA of 2017 to reduce the number of taxpayers subject to the AMT.
Common triggers for the AMT
Here are some of the most frequent scenarios that may cause you to owe AMT.
- High income: If you earn income over the AMT exemption ($85,700 for single filers and $133,300 for married couples filing jointly in 2024), you may be more likely to face the AMT in the future.
- Significant itemized deductions: If you claim large deductions, such as state and local taxes (SALT), property taxes, or miscellaneous itemized deductions, you may be more susceptible to the AMT. The SALT deduction is capped at $10,000 under the TCJA.8
- Exercise of incentive stock options (ISOs): When you exercise ISOs, the difference between the exercise price and the fair market value of the stock may be considered income for AMT purposes, even if you don’t sell the shares.9 This can lead to a substantial AMT liability, especially if the spread is significant.
- High proportion of long-term capital gains in relation to ordinary income: While long-term capital gains are taxed at preferential rates (15% to 20%),10 having a large amount of such income in proportion to your ordinary income can trigger the AMT. This is because the capital gains may cause your AMT exemption to phase out, indirectly subjecting other income to the AMT.
- Tax-exempt interest from private activity bonds (PABs): Interest from PABs, which fund private projects that benefit the public, is tax-exempt under the regular income tax system but considered taxable income under the AMT.11
By familiarizing yourself with these common AMT triggers, you can work with your tax professional to develop strategies that minimize your AMT exposure and optimize your overall tax situation.
Tax treatment of ISOs
ISOs are a popular form of employee compensation, particularly in the tech industry. While ISOs can be a valuable tool for building wealth, navigating their tax implications can be complex, especially with the AMT. Let’s take a closer look at the tax treatment of ISOs and how they interact with the AMT.
No ordinary income tax on exercise, but AMT applies
When you exercise an ISO, you don’t owe ordinary income tax on the transaction. However, for AMT purposes, the “bargain element”—the difference between the exercise price and the fair market value of the stock at the time of exercise—is considered income. This means that even though you have realized no actual profit, you may owe AMT on the paper gain.12
Holding period for favorable tax treatment
To qualify for the preferential long-term capital gains tax rate on the eventual sale of the stock, you must hold the shares for more than one year after the exercise date and two years after the grant date.13 If these holding period requirements are met, you’ll pay tax at the lower long-term capital gains rate (15% to 20%, depending on your income) on the difference between the sale price and your exercise price.
Paying the higher of AMT or regular tax
If your AMT calculation exceeds your regular income tax, you’ll owe the higher AMT amount. This can significantly erode the tax benefits of ISOs if not planned for carefully. It’s essential to work with a tax professional to model the potential AMT impact before exercising ISOs so you can avoid any surprises come tax time.AMT credit for future use
If you pay AMT due to exercising ISOs, you may be able to generate an AMT credit that can be used in future years when your regular tax liability exceeds your AMT.14 However, there are limitations and conditions for using this credit. For example, you can only offset regular tax to the extent it exceeds AMT in subsequent years.
Impact of AMT exemption and threshold changes
Absent congressional action, starting in 2026, you’re more likely to be subject to AMT due to exercising ISOs. The lower exemptions and phaseout thresholds could make it more challenging to avoid. As such, you need to factor in these scheduled changes when developing a long-term strategy for managing ISOs, and you should consider the potential impact on your tax situation in the years ahead.
Strategies for reducing ISO tax liability
Strategies such as timing ISO exercises, considering early sales of a portion of the stock (disqualifying dispositions) and projecting your tax liability under various scenarios can help optimize your outcome.
For example, exercising ISOs early in the year might provide a better gauge of the stock’s performance and help you decide whether to hold or sell the shares before year-end to manage tax impacts. By exercising early, you have more time to monitor the stock’s performance and determine if it’s likely to maintain or increase in value.
Planning for the post-TCJA era
As we approach the sunset of the TCJA provisions at the end of 2025, you should start planning for the potential impact on your tax situation, particularly concerning the AMT.
Tax modeling can help you forecast various scenarios beyond 2025, allowing you to make informed decisions about timing income recognition and deductions to manage your AMT exposure. This may involve strategically accelerating or deferring certain transactions, such as exercising ISOs or realizing capital gains, based on your projected AMT liability.
Additionally, you may need to adjust your investment and tax planning strategies to account for the expected legislative changes. This could include reevaluating your portfolio allocation, considering tax-efficient investment vehicles, and exploring charitable giving opportunities to help offset potential AMT liabilities.
The TCJA sunset is fast approaching, and the time to review and update your tax plan is now. Don’t wait until the last minute to assess your situation and make necessary adjustments. By proactively addressing the potential impact of the AMT changes, you can help ensure a smoother transition to the post-TCJA era and minimize any tax surprises.
If you haven’t already done so, we encourage you to schedule a meeting with your wealth advisor at our firm to discuss your specific situation and develop a comprehensive strategy for navigating the upcoming changes. With careful planning and expert guidance, you can confidently move forward and continue to work toward your long-term financial goals.
Think of the current estate tax breaks as a limited-time offer.
Sources:
- Tax Policy Center. (2024, January). Tax Policy Center briefing book: Who pays the AMT?
- Tax Policy Center. (2024, January). Tax Policy Center briefing book: Who pays the AMT?
- Tax Policy Center. (2020, May). Tax Policy Center briefing book: How did the TCJA change the AMT?
- Durante, A. (2023, November 9). 2024 tax brackets. Tax Foundation.
- Tax Policy Center. (2020, May). Tax Policy Center briefing book: How did the TCJA change the AMT?
- Durante, A. (2023, November 9). 2024 tax brackets. Tax Foundation.
- Joint Economic Committee Congress of the United States. (2018, March 18). The 2018 Joint Economic Report. United States Congress.
- Tax Foundation. (n.d.). State and local tax (SALT) deduction. Tax Edu.
- The Carta Team. (2023, March 2). Incentive stock options (ISO). Carta.
- Internal Revenue Service. (n.d.). Topic no. 409, capital gains and losses.
- NABL. (n.d.). Bond basics: Alternative minimum tax (“AMT”).
- Hanks, S. (2023, August 16). AMT stock options: What you need to know. Brighton Jones.
- Hanks, S. (2023, August 16). AMT stock options: What you need to know. Brighton Jones.
- Frank, A. (2023, December 22). Incentive stock options and the AMT. J.P. Morgan Wealth Management.
Disclosures:
For informational purposes only. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed. Our statements and opinions are subject to change without notice. Always consult with a professional before taking specific action.
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