After the public’s outrage in the 60s about how wealthy individuals were exploiting the regular tax system’s loopholes to reduce their tax liability to almost zero, the AMT was enacted in 1969. The Alternative Minimum Tax (AMT) states that high-earning individuals must pay a minimum amount of taxes even if they are entitled to various credits and deductions.
AMT applies to all the states of the US, including California. This parallel tax system was established to prevent wealthy individuals from reducing their tax obligations through loopholes in the tax system. Understanding the Alternative Minimum Tax is crucial, particularly for those who come under the high-income tax bracket.
There are different AMT rates for different levels of income. Therefore, make sure you know which category you fall in. There are also exemptions that can help you save a few hundred or thousands of dollars. It helps to work with a tax advisor who is equipped with tax knowledge as well as a financial expert, like a CPA in Roseville, California, who can organize and analyze your statements.
Understanding the Alternative Minimum Tax (AMT)
As already stated in the introduction part of the article, the AMT ensures that all high-income taxpayers pay a certain amount of taxes regardless of the deductions and credits available to them. It is a federal tax system in the United States, including California. The AMT functions independently of the regular income tax system and is calculated in a different way.
This tax system was introduced to prevent wealthy individuals from using the regular tax system’s laws to reduce their tax liability. High-income taxpayers must use two systems to calculate their taxes: the regular federal system and the AMT system. If the amount calculated using the AMT system exceeds the federal tax, the individual must pay the larger amount.
What are the factors that trigger the AMT?
Certain factors trigger the application of AMT. These include the following:
1. High gross income relative to taxable income.
A major factor that can make you vulnerable to the Alternative Minimum Tax (AMT) is having a high gross income relative to your taxable income. Taxpayers with incomes above the annual AMT exemption limits are more likely to face this tax. For example, in 2023, the exemption amounts were $81,300 for single filers and $126,500 for married couples filing jointly.
2. Specific deductions and credits.
Certain deductions and credits that are normally allowed under standard tax rules may be limited or not allowed when calculating the Alternative Minimum Tax (AMT). For example, deductions for state and local taxes, personal exemptions, and the standard deduction are generally not permitted under AMT rules. Taxpayers with large itemized deductions, such as mortgage interest and long-term capital gains, are more likely to trigger the AMT.
3. Exercise of incentive stock options.
The exercise of incentive stock options can also trigger the AMT. The difference between the exercise price and the stock’s fair market value at the time of exercise is considered income for AMT purposes. If you are someone who frequently exercises the ISOs, you should be particularly mindful of the AMT, as it can significantly increase your adjusted income.
4. Certain types of income.
Having certain types of income can increase your chances of paying the AMT rate. For example, long-term capital gains and qualified dividends may increase your income levels and push you into the AMT ones. These types of income are taxed favorably under regular tax rules; however, these can increase your tax obligations.
Don’t trigger the AMT!
If you are a high-earning individual, you may find it hard to give a significant portion of your income into taxes. However, paying taxes is also an important part of being a California citizen. What you can do is ensure you do not pay more than you are required to. Hire a CPA today!
