AMT Credit Relief

Beginning in 2007, certain taxpayers will be able to claim old unrecovered AMT credit even if it means getting a refund that exceeds the current year's tax.

On its last day in business, the 109th Congress passed a tax law that was primarily designed to extend certain tax benefits that expired at the end of 2005, but also dramatically changes the rules for claiming AMT credit. The new rule, which takes effect in 2007 and continues through 2012, provides long-overdue relief to many people who deserve it, but also a windfall to many people who don't. Perhaps the most striking aspect of the rule is the poorly designed phase-out rule. Within certain ranges of income people will face a marginal tax rate greater than 100% if their unrecovered credit is large enough. Some of these people have planning opportunities they should consider before the end of 2006.

If you have more than $5,000 of old AMT credit, it will take two or more years to recover the full amount under this rule. People who have more than $31,250 of old AMT credit will not recover the full amount under this rule unless Congress extends it beyond the scheduled expiration.

Read this page and its continuation for a detailed explanation of the law and planning considerations, some of which are time-critical. I have also posted commentary on the new law.

Creditable AMT

To take advantage of the new rule, you need to have paid the kind of AMT that gives rise to a credit. If you paid AMT for reasons other than exercising an incentive stock option, such as claiming a large deduction for state and local taxes, chances are that you are not entitled to AMT credit. The credit is allowed only for "timing items." There are a few others besides incentive stock options (such as accelerated depreciation), but the main focus is on people who exercised ISOs. If you don't have creditable AMT, the new rule won't help you recover the tax.

Long-term

The rule applies only to "long-term unused minimum tax credit." (I'm going to call it "old AMT credit.") You can't use it to recover a credit for AMT you paid last year or the year before. It allows recovery only if you have unrecovered credit from years that are more than three years earlier. The first year this provision applies is 2007 (returns filed in 2008), and for that year you are potentially able to use this rule to recover AMT paid for any year up to and including 2003 (returns filed in 2004). If you have unused credit for more recent years, you'll have to either recover them under the normal rule or wait until the credit ages enough to be recoverable under this rule.

First-in, first-out

You'll have to apply a first-in, first-out rule to determine the age of your credit. For example, suppose you paid $40,000 of creditable AMT for 2003 and another $50,000 for 2005. For 2006 you recovered $30,000 of credit under the normal rule. As of 2007 you have $60,000 in unrecovered AMT credit, but only $10,000 of that amount is eligible for recovery under the new rule. You have to apply your 2006 credit recovery against the credit you had available from 2003 — even if you recovered the credit by selling ISO stock you acquired in 2005.

Annual limit

There's an annual limit on the amount of old AMT credit you can claim in any one year. The general rule (subject to the phase-out rule described later) is that you can recover 20% of the old AMT credit each year. For example, if you have $80,000 of old AMT credit in 2007, you can recover $16,000 for that year.
However, if your old AMT credit is less than $25,000, you can claim $5,000 or the full amount of the credit, whichever is less. For example, if your unrecovered credit is $12,000, you can recover $5,000 per year the first two years and $2,000 in the third year.

The general rule doesn't allow you to recover 20% of the original amount every year. Instead, it allows you to recover 20% of whatever you have left.

This means people with large amounts of old AMT credit won't recover the full amount over a period of five years, even if they avoid the phase-out rule described later. For example, if you have $1,000,000 in old AMT credit, you may be able to claim $200,000 in 2007. That leaves you with $800,000 in 2008. How much can you claim? No more than 20% of that amount, or $160,000. Assuming you continue recovering 20% per year, after five years you'll have recovered about 2/3 of the total, rather than 100%. As currently written, this relief provision will be in effect for six tax years, beginning with 2007 (returns filed in 2008). During those six years you may be able to recover about 74% of a large AMT credit under this rule.

If your old AMT credit is $31,250 or less you can potentially recover the full amount over six years using this rule. With $31,250 you would recover $6,250 the first year (20% of the initial amount) and $5,000 per year for the next five.

Credit is refundable

The main reason this relief provision is such a big deal is that it's refundable. That means you can claim a refund that exceeds the amount of tax you paid through withholding or estimated tax payments. This provision can put a lot of money in your pocket if you have a large amount of old AMT credit.

Coordination with regular AMT credit

You may be in a situation where you can claim at least part of your AMT credit under the regular rule, which requires you to have regular income tax greater than tentative minimum tax. When that happens, you claim the higher of the two amounts, but you don't get to add them together.

Phase-out

Relief under this rule is phased out over the same range of income currently used to phase out personal exemptions. This phase-out has implications that are positively mind-boggling. Details of this rule and a discussion of its implications appear on the next page.