Alternative Minimum Tax (AMT) Planning: Avoiding and Managing the Parallel Tax System

How the AMT Works: The Parallel Tax Calculation

The AMT operates as a parallel tax system alongside the regular income tax. A taxpayer pays the higher of their regular tax liability or their tentative minimum tax (TMT). The TMT is calculated by starting with regular taxable income, adding back AMT preference items and adjustments (which disallow certain regular tax deductions), subtracting the AMT exemption, and applying the AMT rate (26% on AMTI up to $232,600 for MFJ in 2026; 28% above that amount). If the TMT exceeds the regular tax, the taxpayer pays the difference as AMT.

The TCJA significantly reduced individual AMT exposure by nearly doubling the exemption amounts and raising the phase-out thresholds. Before the TCJA, the AMT hit millions of upper-middle-income taxpayers, particularly in high-tax states, because state and local tax deductions were an AMT preference item. The TCJA's $10,000 SALT cap largely eliminated this issue — if you can only deduct $10,000 of SALT for regular tax purposes, there is no excess SALT to add back for AMT purposes.

However, the AMT remains a significant issue for three categories of taxpayers: (1) ISO holders who exercise incentive stock options; (2) taxpayers with very high incomes who have large amounts of tax preference items; and (3) certain business owners with accelerated depreciation, percentage depletion, or other preference items.

The 2026 AMT Parameters

Source: Rev. Proc. 2025-32 (2026 inflation adjustments). Figures confirmed for tax year 2026.

The Biggest AMT Trigger: ISO Exercise

For most practitioners in 2026, the most common AMT issue they will encounter is incentive stock option (ISO) exercise. When an employee exercises an ISO, the spread between the exercise price and the fair market value of the stock is not included in regular taxable income — but it is an AMT preference item under IRC §56(b)(3). The entire spread is added to AMTI in the year of exercise, potentially creating a large AMT liability even though the employee has not received any cash.

The planning challenge is that the employee must pay AMT on "phantom income" — the spread on unexercised ISOs — in the year of exercise, before they have sold the stock and received cash proceeds. If the stock subsequently declines in value, the employee may have paid AMT on income they never actually realized. This was a devastating problem for many tech employees in 2000–2001 when stock prices collapsed after ISO exercises.

ISO AMT Planning Strategies

Spread exercises across multiple years. Rather than exercising all ISOs in one year, exercise enough shares each year to stay below the AMT breakeven point. Calculate the maximum ISO spread that can be recognized without triggering AMT, and exercise that amount annually.

Exercise early in the year. If the stock is likely to appreciate, exercising early in the year gives the holding period clock a head start. If the stock is held for more than one year from exercise and more than two years from grant, the eventual sale qualifies for long-term capital gain treatment, and the AMT paid on exercise generates an AMT credit that can be recovered in future years.

Disqualifying disposition to avoid AMT. If a client exercises ISOs and the stock declines before year-end, they can make a disqualifying disposition (selling the stock before satisfying the holding period requirements) to convert the ISO income to ordinary income. This eliminates the AMT preference item but creates ordinary income. In a year where the stock has declined significantly, this can be the better outcome — paying ordinary income tax on a smaller amount is better than paying AMT on the full spread.

AMT credit recovery. AMT paid on ISO exercises generates a minimum tax credit (MTC) under IRC §53 that can be used to offset regular tax in future years when regular tax exceeds AMT. The MTC is not refundable in the current year but carries forward indefinitely. Practitioners should track the MTC balance for ISO clients and model the recovery timeline.

Other AMT Triggers and Adjustments

Beyond ISOs, the following items can trigger or increase AMT exposure:

• Accelerated depreciation (§56(a)(1)): The difference between regular MACRS depreciation and AMT depreciation (which uses longer ADS lives and straight-line method) is an AMT adjustment. For real property, the ADS life is 40 years vs. 27.5/39 years for regular tax. Bonus depreciation is allowed for AMT purposes, which significantly reduces this adjustment for most taxpayers.
• Percentage depletion (§57(a)(1)): The excess of percentage depletion over the property's adjusted basis is an AMT preference item. This primarily affects oil and gas investors and mining companies.
• Tax-exempt interest from private activity bonds (§57(a)(5)): Interest from certain private activity bonds that is tax-exempt for regular tax purposes is an AMT preference item. This affects investors in municipal bond funds that hold private activity bonds.
• Passive activity losses (§58): Passive activity losses are computed separately for AMT purposes using AMT income figures. This can create a situation where a taxpayer has a regular tax passive loss but an AMT passive income, or vice versa.

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