Alternative Minimum Tax

If you are subject to the AMT, your tax bill could be significantly higher than it would be otherwise. Your tax bill could increase under the AMT in a number of ways, including:

• You could lose deductions for state and local taxes paid.
• If you don't itemize your deductions, you could lose the ability to claim the standard deduction. For tax year 2023, the standard deduction is $27,700 for joint filers and $13,850 for singles.
• If you have qualified dividends and long-term capital gains, they are taxed at federal rates no higher than 20% for purposes of both the ordinary income tax and the AMT. However, the extra income could reduce or even eliminate the amount of income you can exempt from the AMT. For tax year 2023, the AMT exemption amounts are:
  • $126,500 for married couples filing jointly
  • $81,300 for single and head of household filers
  • $63,250 for married couples filing separately
  These exemption figures are automatically indexed to inflation.
• If you have certain private activity bonds that are not exempt from the AMT, they pay a slightly higher rate of interest to compensate for the lack of exemption. Therefore, if you are subject to the AMT, you'll have to include interest from these bonds as part of your taxable income.

If you are subject to the AMT, you will need to file Form 6251 and possibly other forms, depending on the nature of your income and deductions.

If you were subject to the AMT last year or you think you could be subject to the AMT in the future, you can take steps to help minimize its impact. Start your plan now by using the TaxCaster tool; it may help you estimate your potential tax liability under both the regular federal income tax system and the federal AMT system.

Although talking to your tax advisor about your specific situation is always advisable, below are four ways you may be able to reduce or perhaps even eliminate your exposure to the AMT.

1. Check your tax-free mutual funds and bonds

Interest income generated by most state and local municipal bonds is generally exempt from federal income tax and/or AMT.¹ However, if these bonds were used to pay for such "private activities" as housing projects, hospitals, or certain industrial parks, the interest is fully taxable for taxpayers subject to the AMT.

Interest dividends distributed by a municipal bond or money market mutual fund are also subject to the AMT if the fund owns certain private activity bonds. A fund's prospectus will tell you if the fund aims to generate only AMT-free interest dividends. Fidelity offers both AMT-free municipal bond and money market funds that seek to avoid investing in any private activity bonds that generate interest dividends subject to the AMT.

2. Time deductions and tax payments

Let's say you aren’t likely subject to the AMT this year, but you discover that you may be subject to the AMT next year. You may want to consider paying your local and state tax bills (including property tax) before the end of this year. You could also group together other expenses for next year—such as interest on a second mortgage and investment and tax preparation fees—and pay them this year. You'll gain deductions that may otherwise be lost next year, and you may be able to avoid AMT in the current year.

3. Time your capital gains

Under the AMT, a portion of your income may be exempt from tax. This year, the exemption amounts will be $126,500 for married joint filers and $81,300 for unmarried individuals, but the exemption is subject to phase-out based on income. While capital gains generally qualify for the same lower rates under the AMT as under the regular tax rules, a capital gain may cause you to lose part or all of your AMT exemption.

If you hold securities that are not publicly traded, you may be able to manage this situation by delaying a sale into the next year or using an installment sale² to spread the gains and potential tax liability over a number of years.

For example, if you have appreciated private securities that would result in a $50,000 capital gain, you might consider spreading the sale out over two to three years, especially if you have other non-recurring deductions that you want to use. Before taking any action, however, be sure to take into account your long-term financial plans.

4. Be careful with incentive stock options

Typically, you don't have to include income related to the exercise of incentive stock options (ISOs) when calculating your normal tax liability. With the AMT, you must often include ISO income when you exercise the options, regardless of how much longer you hold the shares received. If you are likely to pay the AMT, consider selling your shares in the same year you exercise the options. That way, you'll at least have the cash to pay your AMT bill. You could also think about exercising a few options at a time over several years to spread out the income and potential tax liability.

Consult your tax professional for guidance appropriate to your specific situation on these and other strategies for managing your AMT exposure.