The Amazing Disappearing AMT Credit
July 28, 1999
© 1999 by Michael C. Gray
The Alternative Minimum Tax (AMT) continues to amaze me as I work with it. Although I work with it a lot, in many ways I consider myself a student rather than an expert.
In some ways, the AMT is a prepayment of tax. When the AMT arises from a timing difference, the most significant one for our clients being the tax preference from incentive stock options, it results in a tax credit becoming available to apply against a future year’s regular tax liability. The general rule is the AMT credit may be applied up to the excess of the regular tax liability over the tentative minimum tax liability.
The Federal AMT Credit is computed and the limitation determined on IRS Form 8801. A copy of form 8801 is being provided with this article for your reference.
Page 1 Form 8801
Page 2 Form 8801
For incentive stock options, the credit typically is not all recovered in the year the stock is sold because the regular tax rate for long-term capital gains is 20% while the AMT rate for the tax preference is 26% or 28%. Thus, there is about 6% or 8% of unused credit to be used against other taxable income.
Does this additional credit have much value? As usual, the answer is “that depends…”
In states that have an income tax, like California, I think the taxpayer should discount the value of the credit carryover.
Notice that at Part I of the form, the Net Minimum Tax on Exclusion Items for the previous year is computed. The net minimum tax on exclusion items is computed “as if” the only minimum tax adjustments included items deductible for the regular tax, but not for the alternative minimum tax. The most common exclusion items are state income taxes, real estate property taxes, and miscellaneous deductions.
Also notice that the minimum tax on exclusion items (from line 15) is subtracted from line 16 to arrive at an adjustment amount to the minimum tax credit carryforward. Also note at line 18 that if the minimum tax on exclusion items exceeds the alternative minimum tax from the previous year’s tax return, the adjustment is entered as a negative amount. This will typically happen when there is a negative adjustment on the previous year’s tax return for an ISO disposition, resulting in a zero AMT.
The result is if the AMT credit isn’t used on the previous year’s tax return, it will be reduced on the current year’s tax return.
The minimum tax credit carryforward to 1999 at line 26 of the form is not the amount that will be available to reduce the next year’s regular tax. It will be reduced by the net minimum tax on exclusion items in the 1998 income tax return.
Apparently, Congress is determined that taxpayers should not receive a tax benefit for their state income taxes and other exclusion items when determining the availability of the AMT credit carryover.
So, plan on paying the 26% or 28% federal tax with respect to the tax preference for ISOs. Any benefit that you receive for the AMT credit is gravy.