While the Alternative Minimum Tax (AMT) was a tax originally aimed at larger corporations and high-net-worth taxpayers, today the AMT can also affect small business owners, especially if they are high-earners or take advantage of lots of tax deductions and credits (as they should!).
In today’s post, I’ll break down what a small business owner should know about AMT as well as strategies to reduce or avoid this added tax burden.
What is the Alternative Minimum Tax (AMT)?
Basically, the AMT was put in place by Congress in 1969 to stop high-income earners from using loopholes, deductions, and credits to reduce their tax bill to zero. As the name implies, AMT creates a minimum tax amount that certain taxpayers must pay regardless of how many deductions or credits they could otherwise claim.
How does Alternative Minimum Tax (AMT) work?
The AMT works alongside your regular tax return. The way it works is that if you earn more than an amount set by the government, then the IRS requires you to calculate your tax liability under both the regular tax system and the AMT system. If you owe more in the AMT system than in the regular system, you have to pay the AMT amount.
When you’re calculating your tax liability with the AMT system, that number is referred to as your “tentative minimum tax.” If your tentative minimum tax is greater than your regular tax, the excess amount is the AMT. If your tentative minimum tax is less than the regular tax, then your AMT is zero (but never less than zero).
One other piece to this puzzle is that the AMT system requires the addition of certain income and the disallowance of certain tax deductions that would be permissible under the regular tax system. Some of the common adjustments include:
- Accelerated Depreciation: The AMT often requires slower depreciation schedules for property.
- Interest on Private Activity Bonds: Interest from certain municipal bonds is taxable under AMT even if it’s tax-exempt under the regular tax system.
- State and Local Taxes: While you can deduct state and local taxes (SALT) under the regular tax system, these deductions aren’t allowed under the AMT system.
- Miscellaneous Deductions: Certain other deductions allowed under regular tax rules, such as employee business expenses, are not allowed under the AMT system.
- Incentive Stock Options (ISOs): If you exercise ISOs, this is a big indicator that you’ll need to use the AMT system because the difference between the market price and the exercise price is counted as income under the AMT system.
The final step in calculating AMT is that once you know your AMT income amount, you can apply the AMT exemption, which is a set amount that reduces your AMT income based on your filing status (like the standard deduction for the regular tax system). Once you apply that exemption, the remaining AMT income is subject to AMT rates, which are 26% on income up to a certain threshold and 28% on income above that threshold.
Who has to pay Alternative Minimum Tax (AMT)?
Like I said, AMT was originally intended for those in higher tax brackets (aka super-wealthy). However, nowadays it can affect a range of taxpayers, including small business owners. This is especially true if your business takes advantage of certain deductions or you have large personal deductions for things like state and local tax payments or mortgage interest. Also, if you exercise a large number of incentive stock options (ISOs), you will likely trigger AMT.
It’s also important to understand that although the Tax Cuts and Jobs Act of 2017 (TCJA) made some reforms to the AMT, the tax still exists for individuals. One of those recent-ish changes is that C-Corporations are no longer subjected to AMT at the corporate level. However, if your business is structured as a sole proprietorship, S-Corporation, or partnership, AMT could still apply to you on your personal income tax return.
The IRS sets an AMT exemption amount that adjusts each year for inflation. If your income is below the exemption amount, then you likely won’t need to calculate or pay the AMT. To give you an idea, the exemption amounts for the 2024 tax year are:
- $85,700 for filing single or head of household
- $133,300 for married filing jointly
- $66,650 for married filing separately
How do I know if I owe Alternative Minimum Tax (AMT)?
I highly recommend that you work with a certified public accountant if you think you’ll owe AMT. The calculations for AMT can be complex, and only a tax professional who is well-versed in AMT and how it affects small business owners can work the numbers correctly and help you strategize the best way to reduce your taxable income. That’s the only surefire way to reduce your tax bill regardless of whether AMT applies to your situation for the current tax year.
However, as a general rule, if you have high income, exercise incentive stock options (ISOs), or claim large deductions, you may be subjected to AMT. To get a better idea of how it all works, you can use IRS Form 6251 to calculate your AMT liability. This form walks you through determining your AMT income, applying an AMT exemption, and calculating the tax due.
How can I avoid or minimize Alternative Minimum Tax (AMT)?
While completely eliminating or avoiding the AMT may not always be possible, there are some strategies small business owners can use to minimize it:
- Spread Out Your Income and Deductions: One of the triggers for AMT is large, one-time income or deductions. By spreading income or expenses over multiple years, you can avoid pushing your AMT income above the threshold for AMT liability. For example, if you plan to sell business assets, you could spread the sale over several years to reduce the tax impact to a single year.
- Time Your Deductions and Expenses: Since some deductions, like state and local taxes, are disallowed under AMT, you can time your payments for when they will provide you the most benefit. For example, avoid prepaying real estate taxes to save on that tax bill if paying those bills in the current year will trigger or increase your AMT liability.
- Exercise ISOs Strategically: If you have incentive stock options (ISOs), exercise them in small increments rather than all at once to help reduce the AMT impact. You can also sell the stock in the same year as the exercise to minimize the difference between the market price and the exercise price.
- Maximize Regular Tax Deductions: Since the AMT disallows certain deductions, maximizing the deductions that are allowed under both the regular and AMT tax systems, such as contributions to retirement plans, can help reduce your tax burden.
- Use the AMT Tax Credit: If you have to pay AMT, you may be eligible for the AMT tax credit in future tax years. This credit can allow you to reduce your regular tax liability in years when you aren’t subject to AMT.
The AMT is a complex part of the tax code that can potentially blindside small business owners whose businesses are thriving or have just started to take off. Working with an accountant to navigate this complex tax and to ensure that you’re minimizing your tax liability and staying prepared for any future tax bills will not only help your business succeed but can also help you lower your personal income tax bill.
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