Key Takeaways

• Your tax credit is an asset

• Use the credit to reduce your tax, don’t use tax to reduce the credit

• File form 8801 every year until you’ve used all credits

• To effectively manage your credit is to effectively manage all related financial decisions

• Invest in specialized professionals

Peewee Soccer & Hefty AMT Bills

When adults are around children, we’re always encouraging them when they make mistakes.

As a coach for my son’s soccer team, whenever a child fell on the field, it was so interesting that their initial response was to look at me or one of the other coaches—seeing how we responded to the incident before they either cried out in pain, or got up and kept going.

I and the other coaches were always shouting “Dust it off! You’re good!” or “Hurry, get back on defense! Go go go!”

As coaches, we knew that bumps and bruises during a game were bound to happen… but we also knew that the most important thing was not that a few kids would get bruises, but how those kids reacted to getting bruises. We wanted to teach them a lesson that mistakes or bruises are okay, and that it’s best to keep going. (Don’t worry: if a child was actually hurt, we 100% stopped and took care of them.)

It’s easy to know that we should just dust ourselves off and keep going during a game of peewee soccer, but what about “bruises” in the adult world? Like paying a hefty AMT bill?

THAT hurts. But most of the time, it’s best to follow the coach’s advice: dust it off, keep going, and keep moving forward.

A Different Perspective on AMT Credit

There are a ton of really smart investing strategies with your vested options, and we cover most of them on our blog.

But let’s say you’re past that: you’ve done the exercise, you’ve paid the associated AMT, and now you need advice on how to maximize those AMT credits you’ve earned.

First off: I propose we adjust our thinking.

A lot of people see AMT credits as a way to recover from those additional, painful taxes you paid the year before. (Like seeing a penalty shot as a way to “make up” for the chance to score that you missed.)

But what if, instead, you look at them as a way to reduce income taxes in future years? (Seeing the penalty shot as an incredible, obstacle-free chance to boost your score against the other team, regardless of what just happened.)

I know it’s just semantics, but the way you think about tax credits does influence your behavior towards them… to the point where taxpayers, and even some financial planners, would make great efforts to accelerate income or sell ISO stock as a means to “recover” the credit.

There are times where it would make sense to do this, but there are also times when this strategy would lead you to voluntarily pay more taxes than needed. (Not good.)

Moving forward, think of your credit as an asset. We’ll use this asset to reduce taxes in the coming years, but not use taxes to reduce the credit. ????

The Rules Of The Game

Now that we have the mindset in place, let’s lay the foundation the fundamentals of AMT credits—the rules of the game, if you will:

• Timing items (or deferral items) are needed to create the credit.
• A tax timing item is something that is taxed in one year under AMT, and taxed in a different year under regular tax. Most likely, the timing item triggering AMT are incentive stock options.
• You do not need a timing item to use the credit.
• The credit is generated in the tax year you pay AMT.
• The credit is used in subsequent years when you do not pay AMT.
• The credit does not reduce future AMT.
• Beginning in 2013, the credit is non-refundable, but you may carry over unused credits.
• AMT is a separate calculation from your regular tax, and it is not reduced by deductible items we find on Schedule A, like state income tax or real estate property tax.
• The amount of credit you can use in a given tax year is limited to the difference between your regular tax and alternative minimum tax, and you can only use credits in years when the regular tax calculation is greater than the AMT tax calculation.
• For tax compliance purposes, Form 6251 calculates your alternative minimum taxable income and tax. Form 8801 is the record keeper for any unused credit you want to carry forward.

Manage Your Credits Effectively

Paperwork Compliance: Don’t Lose Your Credits!

That last point above about the forms used is particularly important.

It’s an easily-overlooked item, and a costly mistake to not file the proper forms related to your credits. (In fact, I’d estimate that hundreds, if not thousands, of people overpay on their taxes every year, just because they don’t use the correct forms, especially form 8801.)

You must file Form 8801 to claim the credit, even in years where you use zero credits. You still have to file it to make sure you carry unused credits over to the next year.

(Fortunately, the IRS does give you some grace here. You have up to three years to file an amended tax return, Form 1040-X, or within two years after you paid the tax, using the later of the two.)

But the point is: just file the correct forms every year, so you don’t miss out on credits, and don’t overpay in taxes.

Keep Score & Know Your Numbers

Before you start making big plans for using your credits, remember that you’re limited to how many you can use, because it can’t exceed the difference between your regular tax and tax calculated under the AMT rules.

Here’s an example to show you what I mean:

Previous Tax Year
AMT credits (form 8801) $73,000

Current Tax Year
Regular tax calculation (form 1040) $45,000

AMT calculation (form 6251) $35,000

Allowable credit (regular tax – AMT tax) $10,000

Final tax liability $35,000

Tax withholding (payroll) $42,000

Amount of tax overpaid and refunded   $7,000

Next Tax Year
Unused credits carried forward (form 8801) $63,000

Seems pretty straight forward, right?

One thing worth noting is that the AMT credit is just that–a credit–and not a deduction. (There’s a big difference, and the value a tax credit provides a taxpayer increases the higher they go in income tax brackets.) Thus, the regular tax of $45,000 is reduced dollar-for-dollar up to the limit of $10,000 of allowable.

In this example normally the taxpayer would have to pay an additional tax of $3,000, but with the max AMT credit applied, the taxpayer will receive a refund of $7,000–the source of overpayment coming from taxes withheld from payroll.

Pretty neat, huh?

Decisions, Decisions, Decisions (+ Why You Might Want a Financial Planner)

Still with me?

Good, because we’re going to peel this back one more layer.

Remember, the goal here is to help you build a framework around the various decisions you’ll need to make in the days, weeks, and months to come. Consider this question:

Beyond your stock options and high wages, what factors will hold the greatest impact on the calculation of your regular and AMT tax this year?  

Kind of gives you more questions than answers, doesn’t it?

Don’t worry, this is a good sign: it means you’re on the way to managing your AMT credits much more effectively, and avoiding costly mistakes.

If you ask yourself the question above, you might also find yourself asking things like:

• My spouse quit his job and started a consulting gig this year… this would certainly impact our regular and AMT tax calculation, right? 
• I’ve accepted a job offer starting in two weeks. The base salary is nearly 50% more, and they’re offering a sizable sign-on bonus with company stock… would this impact my regular and AMT tax calculation?

Let’s look at each of these questions and some ways to dig into them to make the most of your AMT credits:

My spouse quit his job and started a consulting gig this year… this would certainly impact our regular and AMT tax calculation, right? 

Yes this will impact regular and AMT tax, but to what degree?

Is he expecting net profits or losses for the year, and how would a loss or profit affect your joint returns? And to what extent can you control such results?

For example, would it be best to fully depreciate qualified home-office property along with the new vehicle he purchased for his consulting business to the current year? Or, would it benefit you more for tax purposes to depreciate the property over its predetermined useful life?

Also, should he take on that new 30-day consulting project in December this year or January next year? What difference would that make, if any?

I’ve accepted a job offer starting in two weeks. The base salary is nearly 50% more, and they’re offering a sizable sign-on bonus with company stock… would this impact my regular and AMT tax calculation?

Yes, if you expect to receive restricted stock awards at your new employer, rather than qualified stock options when you were at your previous employer, the tax planning may generally be less complex when comparing the two scenarios…

But how does this decision influence the original plan you had with your vested options at your previous company–not to mention, now that you only have 90 days to exercise them?

Additionally, you have the sign-on bonus, net of taxes, earmarked for a down payment on a property you are purchasing out-of-state. To help pay the new mortgage and other costs, you mentioned that you plan to use it as short-term rental initially, then eventually move in within the next two years… but you’re short $50,000 cash for the down payment and you need it asap.

Should you sell the stock that you exercised this year, disqualifying them from receiving preferential tax treatment, or perhaps cash out on all of your crypto, which were down over 65% last time you checked? Are there alternative options to consider raising the capital for down payment outside of the exercised stock and crypto?

These are just some of the things tax advisors and financial planners naturally think about when helping you make the most of your AMT credits.

The point is, managing your AMT credits effectively means you’re managing all other relevant financial decisions effectively as well, and looking at the FULL picture, not just at “recovering” from whatever you spent in AMT in a previous year.

Your [Financial] Coach is Here to Help

After paying a hefty AMT bill, you might feel like a kid who just fell and scraped his knee on the soccer field: it stinks, it hurts, and you wish it didn’t happen.

You look to your coach for direction, but instead of babying you, he’s clapping his hands, yelling “Get up! Let’s go! Get back on defense!”

Remember, your AMT credit is an asset, and a really effective way to reduce your future tax liabilities.

When you can work with someone who thinks about this kind of stuff all day every day, you’ll really start to grasp what can potentially impact your regular and AMT tax both now and in the future… giving you the most bang for your buck from those AMT credits you’ve accumulated.

I fully understand that you might not have the time (or desire) toi learn all the intricacies of AMT credit and tax rules, which is why we’re here. Schedule a free call with a qualified KB financial Advisor to learn how we can help you, and take the first step forward with a super-solid financial plan.