Calculating your expected tax bill can be a frustrating experience – it can feel like feeding numbers into a black box without an idea of what answer you’ll get in the end.
But if you open that box, you’ll find two calculations that go into figuring out your tax bill – the normal tax calculation and a second (lesser known) calculation known as the Alternative Minimum Tax (AMT).
As physicians, understanding this lesser-known tax calculation is crucial, as it can significantly impact your tax liability. In today’s post, Dr. Jorge Sanchez will demystify the AMT, explaining how it’s calculated and how it influences your tax return. He will share strategies to help you proactively minimize your AMT liability, maximize your tax savings, avoid unexpected financial setbacks, and ultimately keep more money in your pocket.
What is AMT?
AMT stands for alternative minimum tax.
In simple terms, the AMT is a parallel tax system that operates alongside the regular income tax. Its purpose is to ensure that individuals and corporations with high incomes and significant deductions pay a minimum amount of tax, regardless of the deductions they claim.
AMT simplifies the number of tax brackets. While the standard federal income tax has seven brackets, AMT has two brackets. You are either over $220,700 ($110,350 for married couples filing separate returns) or you are under. If you are over the AMT threshold, your AMT is 28%, and if you are under, your AMT is 26%.
To calculate your AMT amount, you must multiply your AMT tax bracket by your AMT income. Your AMT Income, a.k.a AMTI, is your standard Taxable income with many deductions added back (we’ll dive deeper into this later). Ultimately, AMT reduces the number of deductions you can apply to your taxable income and only has a standard deduction based on your filing status.
When are you required to pay AMT? If your AMT is higher than your standard federal income tax, then you are required to pay AMT. If your AMT is lower than your standard federal income tax, you don’t have to pay AMT.
The AMT calculation is simple, the challenging part is calculating your AMT income. Below, we will review some instances that will increase your AMT income.
Why do we have this second tax calculation?
The AMT was introduced in 1969 to address concerns that some high-income taxpayers utilized various deductions and exemptions to significantly reduce or eliminate their tax liability.
The intention behind the AMT was to create a fairer system that would prevent excessive tax avoidance strategies.
By imposing a separate tax calculation method, the AMT aims to close certain tax loopholes and ensure that taxpayers with substantial financial resources contribute their share to the nation’s tax revenues.
Note that in 2017, when the Tax Cuts and Jobs Acts (TCJA) passed, the income exemptions (discussed later) were significantly raised, which means that very few people find themselves subject to AMT. In 2025, when the TCJA expires, many people will be subject to AMT again.
While the AMT can potentially affect anyone, individuals with higher incomes, large families, and significant itemized deductions are particularly susceptible to the AMT. Higher incomes and substantial deductions increase the likelihood of triggering the AMT.
That said, whether you fall into a high-income bracket or have substantial deductions, knowing the AMT can empower you to make informed financial decisions and optimize your tax planning.
What deductions are disallowed or Limited under AMT?
One key difference between the standard federal income tax calculation and the AMT calculation is taxable income. The AMT income (AMTI) is an adjusted taxable income that limits or disallows many of the deductions allowed with the standard federal income tax calculation.
Below are some of the most common deductions that are disallowed or limited under AMT:
- Standard deductions and personal exemptions are disallowed
- State and local taxes are disallowed
- Real estate property taxes are disallowed
- Incentive tax options are disallowed
- Tax-exempt interest from private activity bonds.
- Depletion and depreciation on certain leased personal and real property are disallowed
- Intangible drilling costs are disallowed
- Medical expenses are disallowed unless they exceed 7.5% of your gross income
- Home equity loan interest paid is disallowed unless the home equity loan was all used for home improvements
- Incentive Stock Options (ISOs) – The difference between the exercise price and the FMV of a stock is not taxed under the regular tax code but is subject to AMT.
- Passive Losses – Losses from rental real estate and other passive investments are treated differently for AMT
- Tax-exempt interest – Municipal bond interest is not subject to regular tax but may be partially (or fully) included in AMT calculations
- Other less common tax credits that reduce your standard federal income tax might also be disallowed under AMT.
You can use your current Federal taxable income and add any disallowed deductions to calculate your AMT income. You can then calculate your AMT by multiplying your AMTI by the AMT tax bracket
What might cause you to have to pay AMT? (Potential AMT Triggers)
AMT triggers are typically experienced by high-income earners or individuals with multiple income streams. These instances are quite common for Physicians who are high-income earners, often have many deductions, and have multiple sources of income.
Certain deductions and exemptions allowed under the standard tax system may be disallowed or limited under the AMT rules. If you have many deductions disallowed by the AMT, you may have to pay AMT.
Some of the most common deductions that can lead to you paying AMT include:
- State and local taxes – uncommon that these alone will require you to pay AMT
- High depreciation or depletion – if you are claiming depreciation or depletion from a business, this can significantly increase your chances of AMT
- High-Value ISO (Incentive Stock Options)
- Large interest earnings from Tax-exempt municipal bonds
- If you are claiming high passive losses due to real estate investments or other passive investments, these can trigger AMT since they are treated differently than the standard federal income tax
- High property taxes from multiple properties are also disallowed and this can commonly trigger AMT, especially if these properties are currently experiencing losses or low passive gains.
Estimating your AMT liability before the end of the tax year will help you make informed financial decisions.
A mid-year projection helps you to evaluate the impact of various financial decisions, such as accelerating or deferring income (if possible), making specific deductions, or exercising stock options.
No one wants to be hit with a surprise year-end tax bill, so you’ll need to calculate your tax under the regular tax rules and AMT to see which one will ultimately be used on your tax return.
By considering the potential impact of the AMT on your financial situation, you can align your goals with tax-efficient strategies and avoid unnecessary complications.
Tactical Strategies to Slash Your AMT
There are some key strategies you can implement to reduce your AMT Income to reduce your chances of paying AMT and staying within the standard federal income tax rates.
1. Adjusting Income Recognition
Managing the timing of income recognition can significantly impact your AMT liability.
One effective technique is to defer bonuses or other income to a later tax year when your overall income is lower (if you have any control over your income). By doing so, you can reduce your AMT exposure.
Adjusting when you are recognizing certain income is a great way to ensure that you don’t pay AMT. For example, if you expect high income from one income source this year and a lower income source this year. You can use this to your advantage by recognizing income from your other income streams the following year.
Another way you can reduce your taxable income is by investing in tax-deductible and tax-efficient investment strategies. For example, if many of your standard tax deductions are disallowed by AMT then maximizing your investments in tax-deductible and tax-efficient investments is a great way to keep you out of AMT.
It’s important to remember that many of these specific investment accounts have limited deductions. To maximize your income, consider the maximum deductions allowed and potentially diversify the number of accounts you invest in
2. Optimizing Itemized Deductions
Identifying deductions that are disallowed under the AMT and prioritizing those that are allowed is crucial.
Some deductions, such as state and local taxes or miscellaneous itemized deductions, may be limited or completely disallowed under the AMT rules.
It is essential to focus on deductions that are allowed under both the regular tax rules and the AMT. Additionally, consider alternative deductions or strategies to maximize your deductions under regular tax rules.
For example, if certain business expenses are disallowed under the AMT, you might explore structuring them as unreimbursed employee expenses.
3. Mastering Exemptions and Credits
AMT exemptions and credits can play a significant role in minimizing your AMT liability.
It’s essential to be aware of limitations on certain exemptions and credits under the AMT rules.
For example, personal exemptions and the standard deduction are unavailable under the AMT, although the AMT has its own (higher) exemption amount. The exemption amount varies each year and depends on your filing status. Maximizing exemptions and credits allowed under the regular tax rules and the AMT can help reduce your overall tax burden.
4. Smart Capital Gains and Losses Management
Capital gains can have a direct impact on your AMT liability, and it’s important to develop tax-efficient strategies for handling capital gains and losses to minimize your AMT exposure.
For instance, if you have capital gains that would push you into the AMT zone, you might consider strategically timing the realization of those gains to spread them across multiple tax years.
Additionally, consider offsetting capital gains with capital losses to reduce your overall taxable income and lower your AMT liability. Understanding the interaction between capital gains and the AMT rules can help you make informed decisions for optimal results.
5. Leveraging Retirement Contributions and Deductions
Contributions to retirement accounts can affect your AMT liability. Making deductible contributions to retirement accounts, such as traditional IRAs or 401(k)s, can help reduce your taxable income and lower your AMT liability.
By maximizing your retirement contributions within the allowed limits, you not only save for the future but also take advantage of the AMT reduction opportunities. This should be considered if you are weighing pre-tax and post-tax retirement contribution options since contributions to Roth IRAs are not deductible and do not directly impact your AMT liability.
6. Seeking Professional Advice
When navigating the complexities of the Alternative Minimum Tax (AMT), the value of seeking guidance from tax professionals and financial advisors cannot be overstated. These professionals possess the knowledge, experience, and expertise to help you effectively manage your AMT liability and develop tailored strategies to maximize your tax savings.
Tax professionals and financial advisors understand the intricacies of the AMT rules and regulations. They stay current with the latest changes and can interpret the complexities of the tax code on your behalf. Their expertise in navigating the AMT can save you time and frustration, ensuring you comply with the rules while minimizing your tax liability.
Seeking professional advice is particularly important when dealing with AMT because it requires a nuanced understanding of your unique financial situation.
Tax professionals and financial advisors can assess your income, deductions, exemptions, and credits to provide personalized strategies that align with your goals and circumstances. They can identify potential AMT triggers and recommend specific actions to minimize your AMT liability effectively.
Consulting with experts allows you to develop a personalized plan based on your circumstances. They can analyze your financial situation comprehensively, considering factors such as your income sources, investment portfolio, business structure, and more. With this in-depth understanding, they can provide targeted recommendations tailored to your needs, ensuring you maximize your tax savings while remaining compliant with the AMT rules.
Final Thoughts on AMT Strategies
Understanding the AMT system and its implications is the first step in minimizing your tax burden. By identifying potential triggers, such as disallowed deductions and exemptions, you can proactively strategize to reduce your AMT liability.
Everyone’s situation is different, so it’s important that you understand your finances very well. Remember to conduct an AMT calculation before the end of the tax year, so you can gain valuable insights into your potential AMT liability ahead of time and prevent unexpected financial setbacks.
Are you currently employing any strategies to minimize your AMT liability? We’d love to hear about your experiences and any tips you might have for other readers. As physicians, what are your biggest challenges regarding tax planning and how can we further assist you in understanding complex topics like the AMT?