When paying AMT, might it make sense to take standard deduction even if it's more expensive?

Question

Due to an ISO exercise, I must pay AMT this year. But this was a one-time thing: I will probably not need to pay AMT next year.

Since ISO exercises are considered a "deferral item", my understanding is this will result in being able to claim an AMT tax credit in subsequent years.

If this is correct so far, is the credit limited to the difference between what I would have paid without AMT, versus what I had to pay? In other words, the extra tax I must pay due to AMT: will I get it back eventually?

I'm wondering because AMT does not allow the standard deduction, and my itemized deductions don't sum to anywhere near the standard deduction. So:

• If I itemize: I pay less tax this year, but the standard tax liability is higher, so the difference between standard tax and AMT is less. (And maybe this limits the credits I can later claim?)
• If I take the standard deduction: I pay more tax this year, but standard tax is lower and so the difference between that and AMT is more. (But maybe this means more credits in later years?)

If AMT credits are limited to the difference between standard tax and AMT, might it make sense to take the standard deduction this year since after the credit is claimed in subsequent years I will have paid less tax overall, even if I paid more this year?

Answer 1

Yes, I think it could make sense in some scenarios. First let me recapitulate the situation you laid out.

Let's say you are single and have a salary of $100,000 in 2021. You also realize AMT income of another $100,000 due to exercising ISOs. If you take the standard deduction of $12,550, you would owe regular tax of $15,015 and AMT of $17,849, for a total bill of $32,864.

If instead you take an itemized deduction of $10,000, all from paying state and local taxes, you would owe regular tax of $15,627 and AMT of $17,237, for a total bill of $32,864. You pay the same total amount but have a smaller credit in subsequent years. This is because state and local taxes are an AMT exclusion item. So this wouldn't make sense.

But if instead you take an itemized deduction of $10,000, all from paying mortgage interest, you would owe regular tax of $15,627 and AMT of $14,637, for a total bill of $30,264. So your total tax bill is $2600 less than if you took the standard deduction. But your AMT credit carryforward is also less, by $3212.

$2600 to $3212 is a return of ~24% in a year, which is quite good. And if your income situation was identical next year aside from exercising ISOs, you could easily get the entire amount credited back to you. So you could certainly justify taking the standard deduction even though you would pay more in taxes this year. However, if you don't want to pay extra this year, or you may be paying AMT for many subsequent years, you might just itemize.

Obviously this will depend greatly on your particular situation, so you'd really need to go through the various scenarios with tax software.

Answer 2

What you are proposing doesn't sound like a good idea. Deliberately paying more ordinary income tax just to reduce your chances of AMT is like cutting off your nose to spite your face. Unless you are subject to AMT every year due to circumstances, you will eventually recover your AMT through the credit process. Most of it will come during the year you sell the stock resulting from this ISO exercise because that's when your spread between your ordinary income tax and your AMT will be the largest. For specific details, check out this ISO AMT Credit link.