💸 Alternative Minimum Tax (AMT) Unraveled: Strategies for the Tax-Savvy Tech Earner

🚀 Good morning. Welcome to this week's edition of "Making Cents of Your Money" with your guide, Dan Pascone.

Today, we're demystifying the confusing Alternative Minimum Tax (AMT)– a sneaky tax consideration that can catch even the most astute tech professionals off guard.

The AMT doesn't care if you're a Silicon Valley superstar or a budding tech entrepreneur; that tax curveball can leave you wondering where your hard-earned money is going. 

Let’s decode the AMT and strip away its complexities so you can plan accordingly and legally keep more of your income away from its reach.

💰More people are making more money, and with more money comes– you guessed it– more taxes.

The Alternative Minimum Tax (AMT) is a parallel tax system created in 1969 largely in reaction to 155 high-income folks with incomes of over $200,000 (worth about $1.9 million today) paying zero federal income tax using deductions not available to the average person. 

Rather than changing the entire tax code for everyone, Congress created the AMT to prevent the wealthiest citizens from using extensive deductions and credits to significantly lower their tax obligations.

While it initially aimed to target 155 of America’s wealthiest people earning nearly $2 million per year, its reach has expanded to affect millions of taxpayers today earning a fraction of that.

💸 Compensation dynamics for high-earners have also changed significantly. 

The Incentive Stock Option (ISO), a significant consideration in AMT exposure, was popularized in the 1950s primarily for executive compensation. 

Today, ISOs are offered to various tech employees from entry-level to C-suite. 

Thanks to some tax tweaks in recent years, the AMT is easier on some high earners than it used to be, and the numbers are adjusted each year to keep up with inflation. 

Still, the AMT exemption levels for 2023 and 2024 are $81,300 and $85,700 for single filers and $126,500 or $133,300 for married couples. 

This exemption shields your Alternative Minimum Taxable Income (AMTI) up to that amount. Any amount over is taxed at one of two rates, 26% or 28%, depending on your AMTI. 

Your AMTI is calculated by adding back in things like certain deductions, credits, and the bargain element from exercising your ISOs.

🚀 Why AMT Matters for You and How to Calculate It

Calculating your AMT is complicated because it requires considering your holistic financial picture, but it’s not rocket science. 

It’s usually calculated automatically by tax software or your CPA, but knowing how the hot dog is made is still useful. 

Basically, you calculate your taxes twice– who doesn’t love doing their taxes two times?–  once under the regular federal income tax system and once under the stricter AMT system, which disallows certain deductions you’d otherwise take. 

You can learn more about calculating AMT and how it’s anticipated to change for tax year 2024 here.

Specifically, stock options can make AMT relevant real fast for tech’s high earners. 

A few AMT triggers include:

📈 Equity Compensation: When Incentive Stock Options (ISOs are exercised, the difference between the exercise price and the market value (the "bargain element") is not considered taxable income for regular tax purposes but is for AMT purposes, which can significantly increase AMT taxable income.

📈 Capital Gains: If you’re holding tech stocks or other assets that can appreciate rapidly, the resulting capital gains from when they’re sold can increase AMT exposure, especially if the gains constitute a significant portion of your annual income.

💰High Salaries: Tech industry salaries are typically higher than many other sectors, increasing the likelihood of hitting the AMT threshold.

🏦State and Local Tax Deductions: Many tech hubs are in states with high state and local taxes, like California and New York. Under AMT rules, many of the deductions available for these taxes in the regular tax system are disallowed, which can increase AMT liability.

🏠Property Tax Deductions: Say you own a house or apartment– the property tax might be tax deductible for federal income taxes, but they’d be added back under AMT rules. 

The AMT is not a penalty or punishment but a key component of understanding the tax implications of your compensation structure and having multiple income streams. 

Still, it’s preferable to ordinary federal rates, which can go as high as 37%, whereas AMT only goes up to 28%. This is a handy comparison if you’re weighing ISOs vs. RSUs—I detail both scenarios here. 

⛅ There’s also some silver lining. 

You could get AMT credits back on exercised ISOs when you sell them. Keep in mind that a tax credit is a dollar-for-dollar reduction in your tax bill, whereas a deduction just lowers your taxable income.

🧠 Making Cents of Your Money: Taming the AMT with Proper Tax Planning

The Alternative Minimum Tax (AMT) can seem daunting and a tad overwhelming initially, but it’s a common reality for high-earners in tech. 

With the right mindset, strategies, and financial planner with specific tech experience, it’s just another day in the office. 

The sooner, the better, but if you’re reading this thinking, “Oh man, I have a boatload of ISOs I can exercise soon,” it’s still not too late to begin planning.

It’s like playing tax Tetris: you want to fit everything just right to avoid triggering the AMT level. 

For example, you can use an AMT exercise calculator to plan to exercise ISOs up to the point where AMT kicks in. 

And remember your investments. Some can bump up your AMT, while others won't touch it, and knowing the difference can save you a chunk of change.

It’s vital to work closely with a financial planner who is well-versed in the nuances of the tax code and the unique tax planning that comes with a lucrative tech career. 

This typically involves a holistic analysis of your integrated financial outlook, goals, and liabilities, and it can lead to fine-tuning your ISO strategy or maximizing AMT credits in the future. 

As you forge ahead in your tech career, remember that AMT isn't just a tax to be paid but a puzzle to be solved, offering confidence to navigate the many opportunities presented by the modern tax code.

Until next week,

Dan from Tailored Cents