Below are four ways you might be able to reduce or perhaps even eliminate your exposure to the AMT. Be sure to consult your tax advisor before taking any action.
1. Check Your Tax-Free Funds
Interest income generated by most state and local municipal bonds is generally exempt from federal income and/or alternative minimum taxes1. But if these bonds were used to pay for such "private activities" as housing projects, hospitals, or certain industrial parks, the interest is fully taxable for taxpayers subject to the AMT.
Interest dividends distributed by a municipal bond or money market mutual fund are also subject to the AMT if the fund owns certain private activity bonds. A fund's prospectus will tell you if it aims to generate only AMT-free interest dividends. Fidelity offers both AMT-free municipal bond and money market funds that seek to avoid investing in any private activity bonds that generate interest dividends subject to the AMT.
2. Time Deductions and Tax Payments
Let's say you discover that you may be subject to the AMT next year. You may want to consider paying your local and state tax bills before the end of this year. You'll gain a deduction that may otherwise be lost next year. You could also group together other expenses – such as interest on a second mortgage and investment and tax preparation fees – and pay them this year. If subject to the AMT, you may not be able to deduct those payments next year.
3. Time Your Capital Gains
Under the AMT, a portion of your income may be exempt from tax. For the 2009 tax year, the exemption amounts for tax year 2009 will be $70,950 for married joint filers and $46,700 for unmarried individuals, but the exemption is subject to phase out based on income. While capital gains generally qualify for the same lower rates under the AMT as under the regular tax rules, a capital gain may cause you to lose part or all of your AMT exemption. If you hold securities that are not publicly traded, you may be able to manage this problem by delaying a sale into the next year or using an installment sale2 to spread the gains and potential tax liability over a number of years. For example, if you have appreciated private securities that would result in a $50,000 capital gain, you might consider spreading the sale out over two to three years, especially if you have other non-recurring deductions that you want to use. Before taking any action, however, be sure to take into account your long-term financial plans.
4. Be Careful with Incentive Stock Options
Typically, you don't have to include income related to the exercise of incentive stock options (ISOs) when calculating your normal tax liability. But with the AMT, you must often include ISO income when you exercise the options regardless of how much longer you hold the shares received. If you are likely to pay the AMT, consider selling your shares in the same year you exercise the options. That way, you'll at least have the cash to pay your AMT bill. Or, think about exercising a few options at a time over several years to spread out the income and potential tax liability.
Consult your tax professional for guidance appropriate to your specific situation on these and other strategies for managing your AMT exposure.
