The Stealth Tax
As the saying goes, “nothing is certain except death and taxes.” That said, no one likes to be confronted with a surprise bill from Uncle Sam, so today we uncover some specifics of the stealth tax, or the alternative minimum tax (AMT). The AMT can be a very complex tax so, as always, your tax professional is the expert in your tax situation and is taking care of these calculations on your behalf when preparing your tax returns.
What is the Alternative Minimum Tax?
The Alternative Minimum Tax, first introduced in 1969, is an additional tax that applies to those individuals with high economic income. During the repeal process in 1982, it was stated that the premise of AMT is that “no taxpayer with substantial economic income should be able to avoid all tax liability by using exclusions, deductions, and credits” (1). While an individual may be able to avoid paying taxes for the year through deductions and credits, the IRS uses AMT as the floor for the percentage of taxes an individual must pay.
As mentioned, the AMT can be an incredibly complex tax to calculate so it is be important to have your tax expert complete the appropriate tax forms if it applies to you.
What Triggers AMT?
If you are worried that you may have to pay AMT, there are indicators to look out for when you file your taxes (2):
- For 2022, income is above:
- $118,100 for married filing jointly
- $75,900 for single filers
- Note – these income levels do not mean the AMT will apply to you if your income is above these levels, they simply reflect the amount of income exempt before AMT might apply. These exemption amounts begin to phase out at high income levels (in 2022: $1,079,800 for those married filing jointly, $539,900 for single filers).
- You have a significant number of itemized deductions
Other common triggers include (3):
- Realizing large capital gains
- While long-term gains are taxed separately from ordinary income, gains are included in the initial steps to calculate AMT and you may realize enough gains to phase out your AMT exemption amounts.
- Exercising stock options
- While not wages, the exercising of stock options is included as W-2 income and is taxed at the Federal level, state level, and for Medicare and Social Security.
- When we are working with you on building a plan for exercising stock options, we know it is vital to work closely with your tax expert to be sure we’re clear on the potential taxes involved with the ultimate action taken.
How is AMT Calculated?
The simplest way to find out if you need to pay AMT is to work directly with your tax expert. They will fill out Form 6251 and determine the Tentative Minimum Tax Calculation, which is then compared with your actual taxes calculated on your income. If the Tentative Minimum Tax is larger than your total tax, you pay AMT equal to the difference.
For more information and instructions on determining AMT, speak with your tax expert or visit the IRS website.
What else is there to know about AMT?
While the AMT was originally set up to make sure the wealthy did not escape their share of taxes through deductions and credits, it wasn’t until 2015 that the AMT exemption amount was indexed for inflation (4). This meant that those in the upper middle-income brackets may have been paying some form of AMT as a result.
As financial planners, tax planning is an important part of our work with our Clients, and if you plan to exercise your stock options, plan to have large realized capital gains (from significant asset sales like a business or highly-appreciated/concentrated stock position), or are looking forward to a big income year, keep in mind, we are good people to think with! We’re happy to discuss any questions you might have about AMT or other tax-related issues, and we will work with you and your tax preparer for the final, expert say regarding your tax liability for the year.
References
- Marples, Donald. The Alternative Minimum Tax for Individuals: In Brief. May 10, 2016.
- Why the Alternative Minimum Tax is Not Just for the Wealthy. WiserAdvisor.
- Adams, Hayden. Beware of These AMT Triggers. Charles Schwab. September 9, 2021.
- Probasco, Jim. Alternative Minimum Tax (AMT). Investopedia. February 28, 2021.