How to Avoid AMT (Alternative Minimum Tax)

The purpose of the AMT (Alternative Minimum Tax) is to ensure that higher earners who also have high deductions pay a minimum amount of tax.
Deferred Compensation
During your professional career, you may receive deferred compensation from your employer. Deferred compensation postpones the receipt of income earned in the current calendar year to a future year or years which practically lowers your taxable income and minimizes the AMT. Typically, deferred compensation is related to pensions and retirement plans. Other forms of compensation such as stock options and bonuses could trigger AMT, but you may be able to control the timing and avoid AMT liability.
Stock Options and Taxing and How to Avoid AMT
It’s important to realize that there are two types of stock options, and each type is treated differently for taxes. Qualified stock options, also known as ISO (Incentive Stock Options), are taxed at the current capital gains tax rate (up to 20%). However, non-qualified stock options are taxes at the holders ordinary tax rates (up to 39.6%). Obviously, there is an advantage for the stock options to be qualified and to be taxed at their capital gains rate. However, qualified stock options are also subject to the AMT. The qualifying event for tax purposes is based on the exercise date of the options even if you plan not sell the stock. The exercise of a qualified stock option may cause you to hit the AMT if the stock has increased significantly in value. Therefore, careful evaluation of your AMT exposure year by year is important. Another way to cover the cost of the AMT is to sell ISO stock (derived from the exercise of the options), or other assets, to get enough cash to pay the AMT tax during the same year you exercise the stock option.
AMT counteracts a portion of the tax benefits someone may receive on qualified stock options. Managing your taxes to avoid or minimize the AMT is difficult but not impossible. Needless to say this is a complicated and important decision. Before deciding what you want to do you, consult with the tax professionals at 212 Tax.