What You Should Know About the Alternative Minimum Tax

Created in 1969 as a way to ensure high-income earners paid their fair share in taxes, the alternative minimum tax (AMT) acts as a parallel tax system to the regular federal income tax system. Taxpayers should technically calculate their income twice—once under the regular tax rules and a second time under AMT—and pay whichever tax bill is the highest. However, most middle-class Americans won’t earn enough to qualify for AMT, though that wasn’t always the case.

While it was introduced in order to increase the tax liability of high earners, AMT was not originally adjusted for inflation. As a result, many middle-class taxpayers became unnecessarily subject to paying AMT.

The 2017 Tax Cuts and Jobs Act (TCJA), which updated requirements around paying AMT, significantly increased the exemptions and phaseout limits, meaning it’s less likely you’ll need to pay AMT. Between 2017 and 2018 (when the provisions were implemented), the number of taxpayers subject to AMT dropped from 5 million to 200,000 in one year, according to the Tax Policy Center.

Unfortunately, if you have incentive stock options and plan to exercise and hold them, even the increased exemption and phaseout limits may not be enough to help you avoid AMT altogether.

It’s also worth noting that the provisions established in the TCJA may expire in 2026 unless further legislative action is taken. If this happens, the AMT’s high exemption limits could drop back down to pre-TCJA levels once again (meaning more middle-class earners could be subject to paying it).

Either way, it’s a good idea to familiarize yourself with this alternative tax system, as you may need to pay it in the future.

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How Is the Alternative Minimum Tax Calculated?

The Alternative Minimum Tax rate is either 26% or 28%, depending on your Alternative Minimum Taxable Income (AMTI).

Finding your AMTI requires a different calculation than what you’d use to determine your regular taxable income. It adds back certain deductions and adjustments into your taxable income, and many of the deductions you enjoy on regular federal taxes do not apply.

AMTI also includes the bargain element of exercising your incentive stock options as income. If you’re unfamiliar with the term, the bargain element of an ISO is the difference between the exercise price of your stock option and fair market value at exercise, multiplied by the number of shares purchased.

For comparison, the bargain element is not counted when figuring your regular income if you exercise and hold the shares. The result of its inclusion in income means exercising ISOs may inflate your AMT in the year you exercise and hold your incentive stock options.

Determining Your Alternative Minimum Tax Base

Once your AMTI is calculated, then the exemption is applied to find your Alternative Minimum Tax Base:

Alternative Minimum Tax Base = Alternative Minimum Tax Income – Exemption

If your AMTI is below the 26%/28% Dividing Line, you’ll be taxed at a flat 26% rate. If AMTI is over the dividing line, then the portion of your income below the dividing line is taxed at 26%, and the remainder is taxed at 28%.

Here’s how that dividing line looks in 2024 & 2025 for all taxpayers:

A Note on the Exemption

If your income is high, part of your exemption may go away. This is known as the phaseout. If you fall into the phaseout, $1 disappears from your exemption for every $4 above the phaseout.

Here is the phaseout threshold for 2024 and 2025:

For individuals with high incomes, your exemption can be reduced to zero.

For the 2024 and 2025 tax year, here is the amount of income taxpayers are able to exempt before AMT is triggered:

Using an Example to Show the Impact of the Alternative Minimum Tax

Let’s assume you’re a married taxpayer with an AMTI of $1,282,700 in 2025. You have exceeded the phaseout limit by $30,000 (Your income of $1,282,700 minus the phaseout threshold of $1,252,700).

This means you must recalculate your exemption, which is $137,000 if you did not exceed the phaseout. Your new exemption is your total exemption amount less a quarter of the amount they exceed (0.25 x $30,000) = $7,500.

Therefore, your new exemption ($137,000 – $7,500) is $129,500, and your new Alternative Minimum Tax Base ($1,282,700 – $129,500) is $1,153,200.

Remember, there are two tax rates: 26% for those under $239,100 and 28% for those over. Given this, your tentative minimum tax would be:

26% x $239,100 + 28% x ($1,152,300 – $239,100) = $317,862

If this amount exceeds your regular tax liability, the amount in excess is the AMT you must pay. For example, if your regular tax is $150,000 and your tentative minimum tax is $317,862, you will pay $167,862 in AMT.

AMTI Counts Exercising Incentive Stock Options as Income

Exercising and holding your incentive stock options counts as income for AMTI calculations. Meanwhile, regular tax calculations do not consider exercising and holding ISO as a taxable event.

Specifically, the bargain element, which is the difference between the price of your incentive stock options at exercise less exercise price of the stock option, multiplied by the total number of stocks purchased, is included in the calculation.

This is not to be confused with a capital gains tax, which is the tax paid when stock is sold.

Since AMTI counts exercising and holding incentive stock options as income, this can lead to an unexpectedly high tax bill for some employees.

Imagine if you exercised 10,000 incentive stock options for Company A at an exercise price of $5 a share. If the current stock price is $85 a share, the bargain element per share would be ($85 – $5) = $80. If all 10,000 shares were exercised, the total bargain element would be $80 x 10,000, or $800,000.

Even though you did not sell these shares, the entire $800,000 is included as income when calculating AMTI. Given the AMT tax rate of about 28%, you could be subject to $220,000 in AMT in the example shared above.

The AMT Credit

Fortunately, selling your incentive stock shares does not typically create additional AMT. Instead, it may lead to an AMT credit.

When you sell your incentive stock option shares as a qualified sale, some or all of the income used to calculate AMT when you exercised the options may be a negative deduction for figuring the AMT in the year of sale. This negative deduction may lead to a tentative minimum tax lower than your regular tax.

If that happens and you have carryforward AMT credit, you may be able to get that credit back in the year of sale. The result may mean a lower tax bill than you would have had otherwise.

It’s possible (but not always the case) that liquidating your incentive stock option shares in a qualified sale can result in an AMT credit equal to the total AMT originally paid.

If you don’t use your full AMT credit in one year, the remainder carries forward to subsequent years for future use.

The Alternative Minimum Tax Crossover Point

It is possible to avoid paying AMT when exercising and holding incentive stock options, but this requires proactive tax planning and knowing your AMT crossover point.

The AMT crossover point occurs when your tentative minimum tax exceeds your regular tax. Remember how AMT is only paid when it’s higher than the ordinary tax rate? This crossover point can be used to your advantage when exercising ISOs.

Let’s assume that in a typical year, your tentative minimum tax is lower than your regular tax rate. If true, we can assume that you have room to exercise some incentive stock options without paying AMT.

To know how much room, you can calculate the difference between your regular tax and tentative minimum tax. Once you know the difference between the two, you can use this to determine how much bargain element you can generate and not pay AMT. The larger the spread between the regular and tentative minimum taxes, the more options you may be able to exercise. The smaller the spread, the fewer options you can exercise.

Let’s assume that you want to exercise some of your ISOs and that you have calculated your regular and AMT taxes to be the following:

• Regular Tax: $70,000
• Tentative Minimum Tax: $50,000

In this scenario, you need to pay the higher of the two calculations, which is currently $70,000 in regular tax. It also means you have a spread of $20,000 between the two tax calculations.

It is possible to determine how much incentive stock to buy by dividing the spread by the AMT tax rate of 28%:

$20,000 / 0.28 = $71,428.57

This number indicates the taxpayer can exercise and hold $71,428.57 worth of bargain element without paying AMT.

Now let’s assume you have incentive stock options with a bargain element of $100 per share, we can determine that you can exercise 7,142 shares (rounded down) to fill the entire AMT crossover bucket.

$71,428.27 / 100 = 7,142 options

Key Takeaways

The alternative minimum tax is not new, but changes created in the 2017 TCJA did increase exemption and phaseout limits. If these provisions continue into 2026 and beyond, they’ll make AMT more forgiving toward the middle class— while potentially generating opportunities to exercise incentive stock options without incurring extra taxes.

It is possible to minimize AMT payments by planning the number of incentive stock options you purchase around the difference between your AMT and regular tax owed.

However, this step requires precise planning and calculations and may be best done near year-end.

Ultimately, every tax situation is different, and you should run a detailed tax calculation for AMT with an advisor before deciding what strategy is best to use around your stock options. If you’d like to speak to our team about your tax planning goals, we invite you to schedule a call with our team today.

This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product. Hypothetical examples contained herein are for illustrative purposes only and do not reflect, nor attempt to predict, the actual results of any investment. The information contained herein is taken from sources believed to be reliable, however, accuracy or completeness cannot be guaranteed. Please contact your financial, tax, and legal professionals for more information specific to your situation. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.