The AMT eliminates all standard and many of the itemized deductions available under the regular tax system. Itemized deductions for state and property taxes, unreimbursed employee business expenses, investment and home equity loan interest, and medical expenses that do not exceed 10% of adjusted gross income are examples of the deductions that are not permitted when the AMT applies.
Under the AMT formula, all disallowed deductions are added back in, and a single AMT exemption is used to reduce your taxable income before the tax is calculated. For tax year 2017, the exemption amounts are $54,300 for single filers and $84,500 for married couples filing jointly. Any income above the exemption levels is then taxed at flat rates of 26% and 28%.
If there is a chance you will be subject to the AMT, you must calculate your tax liability under the rules of both the regular tax code and the AMT, and pay the higher amount. In some cases, the difference in the amounts owed under the AMT and the regular tax system can be substantial. Families may find themselves having to pay the AMT in a given tax year because they have claimed a large number of itemized deductions on top of claiming a large number of standard deductions. Planning away personal exemptions for dependent children is hardly feasible, but there may be ways you can organize your other expenses to avoid entering the AMT zone, or to minimize the amount you owe if you are liable to pay the AMT.
Planning for the AMT means turning the conventional tax planning strategy on its head: instead of accelerating deductions and deferring income, attempt to accelerate your income and defer deductions. Examine all the itemized deductions you expect to claim in this or the coming year, and think about whether it makes sense to try to defer or accelerate those expenses. If you are likely to face the AMT this year, consider deferring payment on state and local taxes, provided any penalties incurred would be lower than the additional taxes owed.
It is not always be possible to control when potentially deductible medical expenses are incurred, but it may be possible to control when the bills are paid. If your employer offers a cafeteria plan, consider using this option to pay medical expenses in advance on a pre-tax basis, rather than claiming an itemized deduction on your tax return. Whenever possible, schedule the payment of any items not deductible under AMT rules, such as business or investment expenses, for years when you are not likely to be subject to the AMT. If you are employed and claim unreimbursed business expenses on your personal income tax return, consider asking your employer to reimburse you directly for these expenses.
Similarly, consider the potential AMT consequences of selling long-term investments, and time those sales accordingly. While long-term capital gains are taxed at the same rate under the AMT as under the regular income tax system, adding a large capital gain to your income can serve to reduce or eliminate the AMT exemption.
Accelerating income may be advisable if the AMT’s flat rates of 26% and 28% are lower than the tax brackets you would be subject to under the regular tax system. Ways to accelerate your income include asking for prepayments of salary or bonus, cashing in certificates of deposit or savings bonds, taking a short-term capital gain, or withdrawing funds from taxable retirement accounts.
It is especially important for AMT planning purposes to take care when exercising employer-provided incentive stock options (ISOs). The difference between the fair market value of the stock at the time of purchase and the amount paid for the stock is considered taxable under the AMT. If you fail to sell the shares in the same year the ISOs were exercised, you could end up with a very large AMT liability. If the stock declines in value during the holding period, you may actually lose money on the transaction. Because of the risks involved, you should always consult your tax professional before exercising ISOs.