Why does the credit for prior year AMT exist?

Question

The ways in which the US alternative minimum tax (AMT) differs from the regular tax fall into two components: excluded deductions (e.g., state taxes) and disallowed deferrals (e.g., exercising ISOs (Incentive Stock Options)). The AMT for the deferral items can generally be clawed back in future tax years by the taxpayer through the prior year AMT credit. I see that this could avoid double taxation when the deferred gains are finally recognized by the standard tax. But why collect a tax one year only to hand it back (minus inflation) in future years? Wouldn't it be simpler to remove the AMT treatment for deferral items completely? Is this just all a complex way for the federal government to get an interest-free loan for a few years? Is there some behavior this is supposed to be incentivizing?

Answer 1

The 10-year revenue impact needs to be estimated for tax legislation, and AMT (Alternative Minimum Tax) on ISOs (Incentive Stock Options) addresses this by reducing the 10-year revenue loss by shifting taxes earlier. Yes, the AMT paid for ISOs is supposed to be recovered over time, but there are reasons where that becomes extremely slow or impossible: death of the taxpayer, continued ISO exercises that reduce/eliminate the MTC (Minimum Tax Credit, or the credit for prior year AMT) recovered each year, already being subject to AMT for other reasons, selling ISO shares at a loss for AMT purposes, etc. Each of those can make the 10-year number look better.

Speaking specifically to "already being subject to AMT for other reasons" - AMT was originally implemented to prevent high-earners from excluding and deducting away large portions of their income. If a taxpayer is subject to AMT without the ISOs, they may never be able to recover their MTC - perhaps by design. The ultra-wealthy can often pass on assets to heirs without needing to realize any gains (if they have more than enough assets to live on elsewhere), which could mean that those ISO shares are never subject to income taxes due to the step-up in basis. AMT is one way the IRS can increase the probability of collecting (and keeping) at least some taxes from the ultra-wealthy's ISOs.

Answer 2

But, why collect a tax one year only to hand it back (minus inflation) in future years?

Applying logic and rational thinking to the tax code is often a futile exercise. Much of it is unfair and doesn't work as intended (which is one of the main complaints from the IRS to the lawmakers)

Wouldn't it be simpler to remove the AMT treatment for deferral items completely?

YES!! It absolutely would be A LOT easier. AMT credit is horribly complicated

Is this just all a complex way for the federal government to get a interest-free loan for a few years?

Perhaps. It's probably mostly inertia at this point. In order to change it, some lawmaker will have to find the time and energy to engage.

Is there some behavior this is supposed to be incentivizing

Not anymore. Due to bad law writing AMT has drifted far away from it's initial intent and even for the initial intent.