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Taxes are a complex aspect of running any business, but for startup founders, the alternative minimum tax (AMT) adds an extra layer of complexity. The AMT differs significantly from regular federal income tax calculations, often catching unsuspecting entrepreneurs off guard.
The last thing any business owner wants is a hefty tax payment they didn't anticipate, which is why understanding how to calculate the AMT is crucial.
In this guide, we'll break down everything you need to know about AMT calculations in a few easy-to-understand steps.
What is the alternative minimum tax and whom is it for?
The alternative minimum tax is a parallel tax system intended to guarantee that individuals with higher incomes pay a minimum amount of tax, irrespective of the tax credits and deductions they claim under the regular income tax system.
The federal AMT provisions establish an alternative set of rules for calculating your personal tax liability, distinct from regular income tax calculations and ordinary income tax rates.
It is also separate from the corporate AMT, which only applies to large corporations that have average annual incomes exceeding $1 billion.
But who exactly is subject to the AMT?
Taxpayers whose income exceeds a certain threshold are potentially subject to the AMT. This threshold, known as the "exemption amount," changes each tax year and varies depending on your filing status and types of income.
Additionally, preference items such as incentive stock options, tax-exempt interest from private-activity bonds, and personal exemptions can trigger the AMT since two primary AMT purposes are to limit these benefits and prevent higher-income earners from avoiding the regular income tax.
The following is a broad overview of the basic process for calculating the AMT:
- Calculate your alternative minimum taxable income (AMTI), which is an adjustment to your regular taxable income that adds back certain preferences and itemized tax deduction amounts.
- From your AMTI, subtract the AMT exemption amounts, which phase out at higher income levels.
- Apply the AMT tax rate(s) to the resulting income to determine your tentative minimum tax (TMT).
- Your AMT liability is the amount by which this tentative minimum tax exceeds your regular tax liability.
Put simply, if your AMT liability is higher than your regular tax liability, you must pay the minimum amount established by the AMT calculation. This makes sure that you contribute a minimum share of taxes, regardless of deductions or credits claimed.
How to calculate the AMT
Calculating the AMT requires a series of steps that go a bit further than your regular tax calculation. Each step involves specific calculations to determine your AMT liability and what adjustments need to be made. Below is a detailed breakdown of these steps.
1. Determine your regular taxable income
Your first step is to calculate your income per the regular tax rules, which is your gross income minus any deductions (either the standard deduction or itemized deductions), exemptions, and credits on your regular tax return.
You can use a regular tax calculator to help you determine the amount, which serves as the baseline for your AMT calculations.
2. Make required adjustments
Next, make the required AMT adjustments to your taxable income. These adjustments include adding back certain itemized deductions from Schedule A, like state and local taxes (SALT) and certain mortgage interest tax deductions.
You also have to add back the standard deduction if you claimed it instead of itemizing, which is only deductible for regular tax purposes. For an exhaustive list of each AMT adjustment, refer to IRS Form 6251.
3. Subtract your AMT exemption
Depending on your income threshold, subtract the AMT exemption amount from your adjusted gross income. The exemption decreases for high-income earners at certain thresholds. Ensure that you're using the correct exemption amount for your filing status.
4. Calculate your AMT income
After subtracting the AMT exemption amount, the result is your AMT taxable income. This amount will be used to compute the tentative minimum tax.
5. Multiply your AMTI by the AMT rates
Once you have your AMTI, you'll apply the AMT rates to it. For the tax year 2023, the AMT rates are 26% and 28%. The rate depends on the level of your AMTI.
For example, for a single filer, the 26% rate is applied to AMTI up to $220,700, and the 28% rate is applied to any AMTI above that threshold. For married couples filing separately, the 26% rate applies to AMTI up to $110,350, and the 28% rate applies to AMTI above that threshold.
6. Compare the TMT to your regular tax liability
Your tentative minimum tax is compared to your regular tax liability. If your TMT is higher, the difference between the TMT and your regular tax liability is the AMT amount that you owe.
7. Complete AMT form 6251
Finally, fill out the alternative minimum tax form 6251 to formally calculate and report your AMT. This form reflects AMT adjustments, taxable income, AMT exemption, and AMT credit, if applicable, to arrive at your tax liability.
By following these steps precisely, you can accurately determine whether you're subject to the alternative minimum tax and, if so, how much you owe. An AMT calculator may help streamline the process.
It's also worth noting that for those abroad, the foreign tax credit may be able to offset a portion of the AMT owed. If you're unsure about your eligibility for this credit, consult with a tax professional.
Maintain your tax compliance
Whether you're learning how to write off business expenses or searching for unique tax breaks to lower your startup's taxes, maintaining compliance is crucial for avoiding penalties and potential legal consequences.
As your business grows and changes, so too will your tax responsibilities. A key part of this is understanding and correctly calculating the alternative minimum tax.
By following the steps outlined above, you can avoid any surprises come tax time and stay in good standing with the Internal Revenue Service.
Make sure to revisit the AMT calculation process each tax year and update any necessary information, such as changes to your filing status or tax laws. Remember, the AMT rules are complex, and you may require the assistance of a qualified tax professional to ensure accurate reporting.
By staying informed about both your personal and your startup's annual tax obligations, you'll be able to spend more time and energy on what really matters — your business.
