AMT credit and net minimum tax on exclusion items: gotcha?

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This topic contains 2 replies, has 2 voices, and was last updated by  gighi 3 months, 2 weeks ago.

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  • #3260

    gighi
    Participant

    First of all, thank you for the amazing material on this web site, on this forum and on the book, it is truly appreciated in a world where even most paid tax advisors have no clue about these topics.

    I am having troubles finding information on the interaction between AMT credit carry forward and net minimum tax on exclusion items. More specifically, let’s imagine this situation:

    – At year 0, I exercise a significant amount of appreciated ISO, and pay hefty AMT.

    – At year 1, I sell a portion (or all) of the shares for a profit. Since I had dual cost basis due to the AMT paid previously, I am able to significantly lower the AMTI below the regular tax (by using the proper amount of negative adjustment under “disposition of property” on form 6251). This will help me recoup some of the AMT credits that have been generated at year 0. However, since the disposition was qualified and thus the long term capital gain kicks in, the difference between regular income and AMTI is not high enough to let me fully recoup the credit, and there is a significant portion of credit carry forward to year 2.

    – At year 2, something very unexpected happens: when filing form 8801, it turns out the credit carry forward is negatively adjusted by the amount of “net minimum tax on exclusion items” calculated on year 1’s data, which is very high because the calculation of the “tentative minimum tax on exclusion items” doesn’t consider at all the dual cost basis of the shares that were sold, and in the “tax computation using maximum capital gains rates” the data is obtained from year 1’s “qualified dividends and capital gain tax worksheet”, which most definitely doesn’t include the AMT cost basis adjustment. Hence, that number becomes much higher than the amount of AMT paid in year 1 (which is 0), which is subtracted from the credit carry forward.

    I really can’t find the rationale for it: why would the government let me lower my AMTI at year 1 by letting me put in the negative adjustment on form 6251, just to take it away at year 2 and reconsider the non-adjusted basis (without negative adjustment) when calculating the “net minimum tax on exclusion items”?

    I still have a bit of hope that I grossly misunderstood the forms, but when using a tax simulation software it confirms my speculations. It seems like this severely affects the ability to recoup all AMT credits in the long run.

    Thanks

    #3277

    Kaye Thomas
    Moderator

    You aren’t alone. Many people who take a close look at those numbers ask similar questions.

    To explain what’s going on I’ll make up some numbers for an example. Suppose that in year 1 (when you sold your ISO stock and partially recovered AMT credit) your overall tax situation was such that if you had not sold ISO stock, you would have owed $10,000 in AMT (in addition to owing regular income tax). Your sale of ISO stock produced a favorable adjustment large enough to permit you to recover $20,000 in AMT credit. Although your credit was $20,000, your benefit from the adjustment was $30,000, because you also eliminated $10,000 in AMT you would have paid. IRS forms take this into account, reducing your carryover by $30,000 rather than $20,000. It may appear that you’re being cheated out of $10,000 of AMT credit, but your actual tax benefit from taking the sale of shares into account was $30,000. The additional $10,000 benefit wasn’t visible on your tax return for year 1, but the Form 8801 calculation is designed to identify it so you don’t get double benefit from those favorable adjustments.

    #3278

    gighi
    Participant

    Thank you Kaye for your reply, it’s appreciated.

    What you are describing makes complete sense to me but, if I’m not mistaken, it’s still different than my issue.

    In my case, had I not sold ISO stocks in year 1 like you are suggesting, the AMT would have still been significantly below the regular income tax at year 1 (thanks to the more generous limits introduced in 2018), so I wouldn’t have had to pay AMT and would have still been able to recoup some of the AMT credits generated at year 0.

    The only scenario in which I could have possibly owed AMT at year 1 is if, completely hypothetically, I had sold the same amount of shares without having a different adjusted cost basis for AMT purposes, which is exactly the scenario that turns out when calculating form 8801 at year 2. While this hypothetical scenario could have happen if I, for example, took advantage of early exercise, it’s not something that was ever feasible in my situation, so that’s what is throwing me off, I don’t understand why I have to have the AMT credit eaten by a scenario from which I definitely didn’t benefit at year 1 (and again, the proof that I didn’t benefit is the fact that had I not sold those shares, I still wouldn’t have owed any AMT).

    Thanks

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