Planning for the AMT

Individuals are subject to two income tax systems: the regular income tax and the alternative minimum tax (AMT). Taxpayers must compute their tax under each system and pay the greater of the two amounts.

AMT is calculated by applying a two–tier graduated rate structure to alternative minimum taxable income (AMTI). For 2024, the rates are 26% on net AMTI up to $232,600 ($116,300 for married separate filers (MFS)) and 28% on net AMTI above that amount. For 2025, the rates are 26% on net AMTI up to $239,100 ($119,550 for MFS) and 28% on net AMTI above that amount. Long–term capital gains and qualified dividends are taxed at the same rate for regular tax and AMT purposes. In arriving at AMTI, each taxpayer also is allowed an exemption amount (adjusted for inflation), which phases out as AMTI reaches certain thresholds. For 2024, the AMT exemption amounts are $133,300 for married joint filers (MFJ), $85,700 for unmarried filers, and $66,650 for MFS. For 2025, the AMT exemption amounts are $137,000 for MFJ, $88,100 for unmarried filers, and $68,500 for MFS. The AMTI phaseout thresholds for these exemption amounts begin at $1,218,700 for MFJ and $609,350 for all others for 2024 ($1,252,700 for MFJ, and $626,350 for all others for 2025) (Rev. Procs. 2023–34 and 2024–40).

Caution: In certain situations, MFS may not only have their AMT exemption phased out but also must add an amount to AMTI (Sec. 55(d)(2)).

In computing AMTI, certain AMT adjustment items and preference items must be considered. Adjustment items, which are generally described in Sec. 56, usually require separate AMT computations and are substituted for the amounts computed for regular tax purposes. These can result in either positive or negative adjustments to regular taxable income in arriving at AMTI. Preference items are described in Sec. 57 and result in amounts added back to regular taxable income because of the preferential treatment the items receive for regular tax purposes. Tax preference items cannot be negative amounts.

Observation: For years 2018—2025, the Tax Cuts and Jobs Act (TCJA), P.L. 115–97, increased the AMT exemption amounts and phaseout ranges. This, combined with the TCJA’s suspension of the personal exemption deduction and the limitation of the deduction for state and local taxes to $10,000 (AMT preference items), means fewer taxpayers are subject to the AMT. However, high–income taxpayers can still be subject to the AMT, albeit at a possibly lower amount than under pre–TCJA law.

Planning tip: With the projected decrease in the exemption amounts and phaseout ranges in 2026, taxpayers may wish to consider accelerating some preference items into 2025 in order to avoid the AMT in 2026 or pay a lesser amount of AMT in 2025 than would be due in 2026. However, practitioners should continue to monitor for legislation extending the increased exemption amounts beyond 2025.

Taxpayers subject to the AMT must also consider the minimum tax credit (MTC) allowed for certain deferral (timing) adjustments. The MTC equals the difference between the actual AMT and the AMT that would have been owed if only the exclusion preferences (permanent differences) were considered in computing the AMT. The MTC prevents the double–taxation of income and the disallowance of deductions inherent in the relationship between the regular tax structure and the AMT structure. Without the MTC, a taxpayer might never benefit from deferral items that trigger the AMT if they pay regular tax in the year the deferral items reverse. The MTC has an unlimited carryforward period.

General approach to AMT planning

Tax planning for a taxpayer subject to the AMT usually requires a multiyear projection of the taxpayer’s income and is complicated by the MTC, negative adjustments allowed in computing the AMT, and the existence of capital gains because of the different rates. No general planning strategy applies to all taxpayers for the AMT; instead, each taxpayer’s situation is different, depending on the types of items causing the AMT. Avoiding the AMT may produce a corresponding or even larger increase in regular tax. General strategies include:

• Accelerating income into an AMT year;
• Making elections that minimize the AMT; and
• Maximizing the benefit of an AMT net operating loss (NOL).

Accelerating income into an AMT tax year

To the extent an MTC is created, the AMT essentially serves only to accelerate the time when a taxpayer pays regular tax. However, when the AMT is wholly or partially due to exclusion (permanent differences) rather than deferral items, any MTC generated will be less than the total amount of AMT paid. Thus, the AMT results in some permanent increase in taxes since not all of the AMT paid reduces future regular tax in the form of an MTC.

Taxpayers subject to the AMT in one tax year but not the next can reduce their taxes for the two–year period by accelerating income and deferring nonpreference deductions if the following conditions are met: (1) the AMT is due wholly or partially to exclusion items and (2) the taxpayer will have a marginal regular tax rate greater than 28% in the subsequent tax year. However, this strategy will not necessarily produce any tax benefit if the AMT is due to deferral items, because of the effect of the MTC carryforward.

Note: Applying the strategy of accelerating income into an AMT year assumes the incremental income will be taxed at the lower AMT rate of 28%. Where the additional regular tax on incremental income will exceed the additional tentative minimum tax generated on that income, any further incremental income will be subject to the higher regular tax rate and defeat the advantage of this strategy. This breakover point can be determined by dividing AMT in that year by the difference between the marginal regular tax rate and the AMT rate. This formula will yield an approximation that is useful only if the additional income does not increase the taxpayer’s marginal regular tax rate (i.e., after adding the incremental income, the taxpayer is in the same marginal regular tax bracket). Also, the possibility of the 3.8% net investment income tax can complicate the situation.

Making elections that minimize AMT

One way of avoiding or reducing the impact of the AMT is to eliminate or reduce tax preference and adjustment items. An effective means of doing this is to make specific tax elections that alter how some deductions are claimed for regular tax purposes. This, in turn, eliminates the AMT adjustment or preference item associated with that particular deduction.

Caution: The following elections will often impact the computation of taxable income for regular tax. Thus, the effect on both taxable income and AMTI should be considered before an election is made.

Depreciation of property placed in service after 1998

The recovery periods for both the regular tax and the AMT are those of the regular modified accelerated cost recovery system (MACRS). The longer recovery periods of the alternative depreciation system inSec. 168(g) are not required for AMT purposes, but the 150% declining–balance method generally applies. Taxpayers who elect either of the following methods for regular tax purposes avoid or further reduce an AMT depreciation adjustment:

• Sec. 168(b)(3) allows taxpayers to elect the straight-line method, with no effect to the recovery period. This election eliminates any AMT depreciation adjustment. The election is only necessary for personal property since straight-line depreciation is already required for real property.
• Sec. 168(b)(2) allows taxpayers to elect the 150% declining-balance method to eliminate the AMT depreciation adjustment for property and still use an accelerated method of depreciation for regular tax purposes. The election eliminates the portion of the AMT depreciation adjustment caused by methods because the 150% declining-balance method is used for both regular tax and the AMT.

Client advice: Bonus depreciation claimed on eligible assets (must be placed in service prior to 2027) will result in no AMT adjustment.

Research-and-experimental (R&E) expenditures paid or incurred after 1986

Beginning with 2022, amortization over 60 months (180 months if attributable to foreign research) applies (as opposed to a full deduction in the year incurred allowed in years prior to 2022) (Sec. 174). No AMT adjustment will be required if the taxpayer materially participates in the activity (Sec. 56(b)(2)(C)). Otherwise, an adjustment must be made for the amount of the deduction for regular tax in excess of the amount that would be allowable if the expenditures had been capitalized and amortized over 10 years (Sec. 56(b)(2)(A)(ii)).

Sec. 59(e) provides an election to capitalize R&E expenditures and amortize them over a 120–month period beginning with the month in which the expenditure is paid or incurred. This election can be made annually for any portion of the expenditure and is revocable only with the IRS’s consent. Any expenditure for which this election is made is not treated as a tax preference item.

Note: The amortization election is not available for expenditures that are chargeable to an asset that is subject to depreciation or amortization, including assets that originate from R&E expenditures (Regs. Sec. 1.174–4(a)(4)). For example, if the expenditures lead to the issuance of a patent, the costs are amortizable only until the patent is issued. At that point, the taxpayer must recover the unamortized expenditures through depreciation deductions over the patent’s useful life rather than through continued amortization as R&E costs. This may be a factor in deciding whether to make an amortization election, since the creation of an asset may extend the period over which these costs will eventually be recovered. In addition, R&E deductions claimed as incurred under Sec. 174(a) are not required to be recaptured as ordinary income upon the disposition of the property (Rev. Rul. 85–186).

Intangible drilling costs

Generally, intangible drilling costs (IDCs) incurred with respect to oil, gas, and geothermal wells must be capitalized and depleted over the life of the mineral property. However, if the taxpayer has made an election under Sec. 263(c), the IDC is deducted when paid or incurred.

If the taxpayer elects to expense IDC currently, the deduction may result in an AMT preference. The preference equals the amount by which the excess IDC is greater than 65% of the taxpayer’s net income from oil, gas, and geothermal properties for the tax year (Sec. 57(a)(2)). Excess IDC equals the IDC deduction amount from productive wells, less the amount that would have been deductible if the productive IDC had been capitalized and (1) amortized over a 120–month period beginning the month production starts or (2) at the taxpayer’s election, depleted using cost depletion (Sec. 57(b)). Excess IDC is no longer a preference item for independent producers. However, AMTI cannot be reduced by more than 40% because of the repeal of this preference.

Sec. 59(e) provides an election to capitalize IDC and amortize it over a 60–month period beginning with the month in which the expenditure is paid or incurred. This election can be made annually for any portion of the expenditure and is revocable only with the IRS’s consent. Any IDC for which this election is made is not treated as a tax preference item.

Various factors should be considered before recommending that a taxpayer make one of these elections. The types of items that cause a taxpayer to be subject to the AMT as well as the period over which the taxpayer is likely to be in an AMT position are both significant factors.

If a taxpayer’s AMT results primarily from deferral or timing preferences, the AMT will likely become an MTC carryforward that will offset future regular tax. Therefore, any AMT paid in the current tax year may be recovered as a credit against regular tax in the next few years. Here, electing a slower depreciation method or recovery of the deductions discussed previously would reduce the amount of the MTC carryforward in exchange for larger deductions in future years for regular tax purposes. Trading a credit for a deduction is generally not a good trade–off. Instead, the taxpayer is probably better off using the faster deduction recovery period and the resulting MTC to offset regular tax in future years.

Alternately, if a taxpayer’s AMT is caused primarily by exclusion preferences for which no MTC carryforward is allowed, the AMT paid in the current year becomes a permanent tax. Here, electing a slower depreciation or other recovery period for the expenditures described previously may be beneficial by saving future regular tax deductions.

Caution: These elections apply for both regular tax and AMT. Many are made on a year–by–year basis and are not binding on future expenditures. However, once an election is made, it is generally irrevocable for those particular expenditures. Thus, taxpayers should carefully analyze the long–term impact before making one of these elections.

Note: Taxpayers may also consider these elections for reasons other than to avoid or reduce the impact of the AMT. For example, taxpayers with charitable contribution carryforwards that will expire soon may want to make these elections to increase current–year taxable income. This can be an effective way of using carryforwards before they expire.

Maximizing the benefit of an AMT NOL

A taxpayer who has an NOL for regular tax purposes may also have an NOL for AMT purposes. However, the amount of the AMT NOL may be different from the amount of the regular NOL. The AMT NOL is equal to the regular NOL modified by AMT adjustments and reduced by items of tax preference, but only to the extent the preference items are included in the regular NOL (Sec. 56(d)(2)).

Observation: Sec. 56(d)(2) provides that the AMT NOL deduction is computed by starting with the regular tax NOL and making certain modifications. This implies that a taxpayer must have a regular tax NOL before there can be an AMT NOL. In IRS Letter Ruling 9321003, however, the IRS interpreted the statutory language and legislative history related to the AMT to mean that the AMT NOL should be computed using the same methodology used in computing a regular NOL (with adjustments) rather than starting with the regular NOL and making adjustments. Thus, there can be an AMT NOL and no regular tax NOL or vice versa.

Example. Effect of tax preference items on AMT NOL: J reports income of $200,000 with $300,000 of related deductions on his Schedule C, Profit or Loss From Business (Sole Proprietorship), for a regular–tax NOL of $100,000. Included in the deductions is $10,000 of tax preference depreciation (regular tax depreciation exceeds AMT depreciation). J has no other income or deductions. His AMT NOL is $90,000 ($100,000 regular tax NOL − $10,000 tax preference depreciation). For AMT, the NOL is reduced by the amount of tax preference depreciation because the depreciation increased the regular–tax NOL.

The AMT NOL must be carried to the same year as the regular NOL. The AMT NOL deduction is limited to 90% of AMTI determined without regard to the AMT NOL.

Note: The TCJA repealed the general NOL carryback rules (special two–year carryback is still allowed for certain farming losses). Presumably, this same rule applies for AMT NOLs and, therefore, prevents the carryback of an AMT NOL, since the general rule is that the AMT NOL deduction for a given year (including a carryback year) is allowed in lieu of the regular NOL deduction allowed under Sec. 172 (Sec. 56(a)(4)). Practitioners should watch for further guidance.