Understanding the Relationship Between the Standard Tax Liability and the Tentative AMT Liability
Hi everyone. My name is Tan, and I am an independent Certified Financial Planner Practitioner at TAN Wealth Management. This video and the following videos are designed for those who want to learn and understand the relationship between incentive stock options, regular tax liability, AMT liability, and AMT credits so they can make an informed decision to optimize their incentive stock options. What better way to learn the materials than doing examples because we learn more by doing. We are going to start with the basics in this video and then increase the complexity in the following videos.
Understanding the relationship between the standard tax liability and the tentative AMT liability.
For example, Ace is single, and he is a California resident.
The Federal’s standard deduction is $12,950.
The California's standard deduction for state income taxes is $5,202.
This is our baseline for the following examples in this video.
Scenario 1
$0 salary
Max before AMT is $75,901
Total Federal Tax is $0
Scenario 2
$1 salary
Max before AMT is $75,900
Total Federal Tax is $0
Scenario 3
$75,900 salary
Max before AMT is $36,409
Total Federal Tax is $9,466
Scenario 4
$307,900 salary
Max before AMT is 57,671
Total Federal Tax is $77,957
Scenario 5
$539,900 salary
Max before AMT is $92,537
Total Federal Tax is $161,245
Scenario 6
$1,000,000 salary
Max before AMT is $186,735
Total Federal Tax is $335,364
What did we learn?
- No AMT liability because we only have earned income from our salary.
- The higher the salary, the higher the bargain element before triggering AMT, but there is a point where the max before AMT decreases and then increases. I ran some more numbers, and as we can see, the max before AMT decreased to about $180,000 of salary and then increased.
$100,000 salary
Max before AMT is $32,701
$150,000 salary
Max before AMT is $28,699
Scenario 7
$180,000 salary
Max before AMT is $26,392
Total Federal Tax is $33,928
$185,000 salary
Max before AMT is $26,623
$190,000 salary
Max before AMT is $27,776
$200,000 salary
Max before AMT is $30,084
Why did the max before AMT decrease to about $180,000 salary and then increase?
Here is the direct quote from a tax specialist I have a relationship with, “we should expect the "max before AMT" amount to change as other income elements to change. That's AMT only comes into play if/when the tentative minimum tax that's calculated on Line 9 of Form 6251 exceeds the standard tax obligation. When that happens, the difference between those two amounts is technically your amount of AMT.
As your regular income increases (which is what would happen with higher wage amounts), so does your standard tax obligation.
As an example, in your current Scenario 4 where wages are $307,900. Assuming the standard deduction, the tax bill for that would be $76,986. So for there to be AMT, your tentative minimum tax amount needs to be more than $76,986. Technically this occurs when you exercise $57,672 of ISOs, which generates AMT of $1. You can check this by clicking on the calculator tab in the AMT row, which will bring up a line-by-line audit that matches Form 6251.
https://www.irs.gov/pub/irs-pdf/f6251.pdf
For amounts that are right around the "Solve for max" number, you may not see a huge difference between the tentative minimum tax and the standard tax obligation in that audit trail. But due to rounding, technically AMT would be due.”
Let’s look at Form 1040, the salary is on Line 1a, and then we minus the standard deduction on Line 12, which equals our taxable income on Line 15. Taxable income multiplied by the tax rates equals our standard tax liability, Line 16.
https://www.irs.gov/pub/irs-pdf/f1040.pdf
Now, let’s look at Form 6251. On line 1, “enter the amount from Form 1040 or 1040-SR, line 15.” Our taxable income from Form 1040, Line 15, goes there. Assuming everything else is zeros and Line 4, alternative minimum taxable income equals the same number as our taxable income because all the other line items are zeros. Alternative minimum taxable income subtracts the alternative minimum tax exemption equals Line 5, and then we multiplied by the alternative minimum tax rate(s) equals our tentative minimum tax, Line 9. Line 9 is our tentative AMT liability.
https://www.irs.gov/pub/irs-pdf/f6251.pdf
Now we are comparing Form 1040, Line 16, standard tax liability, which is also on Form 6251, Line 10 to Form 6251, Line 9, tentative AMT liability.
That is an extremely high overview for simplicity. Why the max before AMT decreases at about $180,000 of salary and then increases has to do with how numbers are calculated at different tax rates and comparing the standard tax liability with the tentative AMT liability.
If we had exercised ISOs and did not sell the share in the same calendar year, the bargain element would be added on Form 6251, Line i, “exercise of incentive stock options (excess of AMT income over regular tax income).” This will increase our tentative tax liability but not our standard tax liability. If we were subject to AMT liability because of exercising ISOs, we would have an AMT credit that we can use for future years as long as our standard tax liability is higher than our tentative AMT liability.
Understanding the relationship between the standard tax liability and the tentative AMT liability could be hard to comprehend. That’s why I have multiple videos with examples of ISOs and AMT. Watching my other related videos on this subject can help you to understand it better.
Please note that this material is for educational use only, and it’s subject to change. Tax laws are complex, there are exceptions to the rules, and it’s constantly changing. Be sure to talk to a qualified professional before making an informed decision. Thank you for watching. Until next time. This is Tan, your Trusted Advisor.