As a startup employee with options or shares in your company, you may be encountering the alternative minimum tax (AMT) for the first time. Before the AMT, many high-income filers could largely avoid federal income tax liability by taking a variety of deductions and exemptions. The AMT eliminates many of these when incomes rise to specified levels, requiring more of these filers to pay at least a minimum amount of tax.
How does the AMT work?
Each year, the tax code specifies an AMT exemption amount. Filers who report incomes that exceed this exemption amount must complete the AMT calculation in addition to the regular income tax calculation. Whichever calculation results in a higher amount of tax is used for that year’s return.
How much is the AMT?
In 2022 and 2023, a tax rate of either 26% or 28% is applied to alternative minimum taxable income (AMTI).
- For 2022, the 28% rate is applied to alternative minimum taxable incomes of at least $206,100, regardless of whether they’re reported on individual or joint returns.
- For 2023, the 28% rate will apply to incomes above $220,700.
Married couples who file separately reach the 28% rate at half these income levels. Keep in mind, however, that for most taxpayers subject to the AMT, the 26% or 28% rate applies only to income above the applicable AMT exemption amount. However, this exemption begins to phase out at higher incomes (for individuals, $539,900 in 2022 and $578,150 in 2023).
Who has to complete an AMT calculation for 2022 & 2023?
For tax year 2022, the AMT exemption amounts are
- $75,900 for individuals
- $118,100 for joint filers
- $59,050 for married couples filing separately
Anyone reporting incomes above these amounts on their federal tax return will need to complete the AMT calculation. Exemption amounts for 2023 will be higher:
- $81,300 for individuals
- $126,500 for joint filers
- $63,250 for married couples filing separately
What tax benefits are excluded from the AMT?
The AMT excludes several tax benefits, including the standard deduction ($12,950 for individuals and $25,900 for joint filers in 2022), state and local income tax, property tax, and more. Importantly for startup employees, the bargain element of incentive stock options (ISOs) that are exercised but not sold in the same year, which is excluded from regular federal income tax, is included in the AMT calculation. Capital gains from qualified small business stock acquired before September 28, 2010, and held more than five years are also includable for the AMT.
Can I avoid paying the AMT?
By working with experienced tax and financial planning professionals, startup employees can often avoid many of the worst impacts of the AMT. Here are a couple of tactics that frequently benefit employees who receive equity compensation:
Annual Income Projections & Strategic ISO Exercise
Work with your trusted financial advisor to complete income projections each year. If you have incentive stock options, waiting until year’s end to exercise them may allow you to exercise and hold just enough to keep your tax bill under the AMT at or below your ordinary income tax liability. By practicing this strategy over multiple years, you may be able to exercise large numbers of ISOs without incurring additional taxes under the AMT.
IRS Code Section 83(b) allows many employees who receive equity compensation to claim the related taxable gain early—in the year shares are received instead of when they vest. A taxpayer can take advantage of this provision by filing an 83(b) election within 30 days of exercising stock options or receiving a restricted stock award. The fair market value of shares in pre-IPO companies is typically at or near the strike price employees pay, often resulting in little or no tax liability at this stage.
Be aware, however, that filing an 83(b) election is not without risk. If the share price unexpectedly declines, not only will you lose money on your investment, but you won’t be entitled to a refund based on your overpayment. Be sure to discuss the potential benefits and risks with your trusted advisors before filing an 83(b).
RSU “Silver Lining”
Restricted stock units (RSUs) are subject to ordinary income tax, not the AMT. This can result in a steep increase in taxable income for employees holding double-trigger RSUs, which may all be taxable in a single year. If you’re also holding stock options, the silver lining is that the large increase in ordinary taxes can give you some cover to exercise ISOs without resulting in additional tax burden under the AMT. Work with a trusted tax professional who has experience advising pre-IPO employees when determining the best way to manage RSU vesting and the optimal number of options to exercise each year.
Fiduciary Investment & Tax Guidance
WRP Wealth Management specializes in helping pre- and post-IPO employees and executives make the most of their equity compensation. Using academically proven investment strategies and individualized financial planning, we design tax-efficient plans to help our clients reach their financial goals. For more tips on maximizing your equity income, browse our library of free resources.