Understanding Form 6251 and Alternative Minimum Tax (AMT)

Navigating the complexities of tax preparation as per current regulations is an important aspect of running a startup. As a founder, understanding these regulations can significantly impact your business's financial health. One key tax form you need to be familiar with is Form 6251, which is vital for determining the Alternative Minimum Tax (AMT) that you may owe. 

This form can have a direct impact on your financials, especially if you are dealing with stock options or any other form of equity compensation. In this blog, we will cover the different facets of Form 6251, including its purpose, filing dates, important sections, and how it relates to AMT. Keep reading to learn more.

What is Alternative Minimum Tax (AMT)?

The  AMT is a separate tax system in the US designed to ensure that certain individuals, particularly those with higher incomes, pay a fair share of taxes. The AMT operates alongside the standard tax system and has its own set of rules and rates implemented by the United States federal government.

Essentially, taxpayers with relatively high incomes are required to compute their income tax twice: once under the standard tax rules and once under the AMT rules. They then are expected to pay the larger amount of the two calculations. The AMT aims to prevent taxpayers from significantly reducing their tax liability through certain deductions or tax breaks.

Prior to the AMT, some high-income earners legally paid minimal taxes due to how certain income and expenses were treated. The AMT addresses this by recalculating income tax after adding specific tax preference items to the adjusted gross income. This ensures that even with deductions, taxpayers contribute a minimum amount in taxes.

Factors Influencing the Alternative Minimum Tax

Multiple factors can affect AMT calculation, impacting whether you are subject to this tax and the amount you may owe. Here are the factors reported on Form 6251 and how they play a crucial role in determining your overall tax liability.

• Income Level: Your income level can significantly influence whether you are subject to the AMT. If your income exceeds certain thresholds (specified above), you may need to calculate your tax liability under the AMT as well as the regular tax system. Then, you are required to pay the higher of the two amounts as tax.
• Filing Status: Your filing status (e.g., single, married, filing jointly, head of household, etc.) can also affect the calculation of the AMT. The IRS sets different exemption amounts for each filing status, and this information is readily available on Form 6251.
• Deductions: Certain deductions you claim on your regular tax return may not be allowed or might be limited for AMT purposes. This can include deductions for state and local income taxes, interest on home equity loans used for non-improvement purposes, and certain depreciation methods. Form 6251 has specific sections for reporting these adjustments. Remember, claiming deductions that reduce your regular tax liability might inadvertently push you into AMT territory.
• Type of Income: Certain types of income, such as interest income from specific private activity municipal bonds, can make you subject to the AMT. These income types are added back to your taxable income when calculating the AMT, increasing your tax liability.

Incentive Stock Options and AMT

Incentive stock options (ISOs) can be a powerful tool for motivating your team by giving them a stake in the company's success. However, exercising ISOs can also trigger an unexpected tax liability in the form of AMT.

• How ISOs work: ISOs allow employees to purchase company stock at a predetermined price (strike price), typically lower than the Fair Market Value (FMV) at the time of exercise. This difference between the strike price and the FMV, known as the bargain element, is regarded as a tax preference item for AMT calculation.
• ISOs and AMT: If you exercise ISOs that are 'deep in the money' (meaning the market price of the stock is significantly higher than the exercise price), the bargain element can be substantial, potentially triggering the AMT. The larger the bargain element, the greater the potential impact on your AMT liability.

What is IRS Form 6251?

IRS Form 6251, officially known as the Alternative Minimum Tax—Individuals, is a tax document utilized by the Internal Revenue Service (IRS) to calculate the potential AMT that a taxpayer might owe. This form comes into play when taxpayers with substantial incomes leverage certain deductions to decrease their tax bill.

The AMT operates as a safeguard, establishing a ceiling on these tax benefits to make sure that individuals with higher incomes contribute a fair share of taxes. It acts as a balancing mechanism in the tax system, preventing excessive deductions and ensuring tax equity. Hence, if you fall into the taxpayer category for which the AMT is applicable, your tax obligation will be determined by the AMT instead of the standard deduction in the individual tax return.

Who should file Form 6251? 

The requirement to file Form 6251 depends on specific income thresholds and other criteria. For the tax year 2024, the Internal Revenue Services (IRS) has set the following guidelines for the Alternative Minimum Tax (AMT):

• For those filing taxes individually, the amount exempted from the AMT is $85,700. While married couples filing their taxes together get an AMT exemption of $133,300.
• The 26% AMT tax rate applies to Alternative Minimum Taxable Income (AMTI) up to $232,600 for single filers and up to $116,300 for joint filers.
• A 28% AMT tax rate applies to AMTI above these amounts.
• The AMT exemption starts phasing out at an AMTI of $609,350, regardless of filing status.

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In addition to the income thresholds discussed here, there are specific conditions under which you must attach Form 6251 to your tax return. These conditions include:

• If line 7 of Form 6251 is greater than line 10, you must file the form. This indicates that your AMT calculation exceeds your regular tax amount.
• If you are claiming any general business credit and either line 25 of Form 3800 or line 6 in Part I is higher than zero, you need to file Form 6251. This is because these credits can reduce your AMT.
• If you are claiming the the personal-use portion of the alternative fuel vehicle refueling property credit (Form 8911), qualified electric vehicle credit (Form 8834), or the tax credit for last year's minimum tax (Form 8801), you need to file Form 6251. These credits can influence your AMT calculation.
• If the sum of lines 2c through 3 on Form 6251 is negative and line 7 would be more than line 10 without considering lines 2c through 3, you have to file Form 6251. This could happen if you have certain types of deductions or adjustments.

When to File Form 6251? 

Filing deadlines can be stressful, especially for busy startup founders like you. However, when it comes to Form 6251, knowing the key dates can save you time and potential penalties. Here is a breakdown of these dates for 2025 to ensure you meet the filing requirements:

• April 15, 2025: This is the standard tax filing deadline for most US taxpayers. Just like your regular tax return (Form 1040 or 1040-SR), Form 6251 should be submitted by this date to avoid late filing penalties.
• June 15, 2025: If you are a US citizen living and working abroad, you have an automatic extension to file your taxes until June 15. This also applies to Form 6251.
• Extension Option: If you need to catch up on your taxes, the IRS offers extensions, which postpone the due date for Form 6251. Be sure to file the appropriate extension form (typically Form 4868) before the standard deadline to avoid penalties.

You must complete the filing deadline to avoid a late filing penalty. This penalty is usually 5% of the tax owed for every month or part of the month for which your return is late, but it can go up to a maximum of 25%.

Sections of Form 6251 explained

Each section of Form 6251 is integral to determining whether you owe the AMT and, if so, how much. Let's break down the key sections and what information they require.

1. Part I: Alternative Minimum Taxable Income (AMTI): This section adjusts your income and deductions. It includes entries for items like medical expenses, taxes, home mortgage interest, and miscellaneous deductions. Accurately calculating your AMTI is crucial, as it forms the basis for determining your AMT liability.
2. Part II: Alternative Minimum Tax (AMT): This part recalculates your AMTI. It includes calculating your AMT exemption amount and applying the AMT rates (26% or 28%) to the amount that exceeds the exemption. This section determines your tentative minimum tax.
3. Part III: Tax Computation Using Maximum Capital Gains Rates: This section is used if you have capital gains or qualified dividends. It calculates the tax using maximum capital gains rates and compares it with the tentative minimum tax calculated in Part II.

How to calculate AMT?

AMT calculation involves a series of steps using Form 6251. Here's a step-by-step guide to help you navigate this process:

• Enter Your Taxable Income: On line 1 of Form 6251, begin by entering your taxable income from IRS Form 1040 or 1040-SR.
• Enter Adjustments and Preferences: From line 2a to line 3 of Form 6251, enter amounts for any items that apply to you. These could include certain deductions, such as state and local taxes, that are disallowed for the AMT.
• Calculate Alternative Minimum Taxable Income (AMTI): Add up all the amounts from lines 1 to 27 and enter this total on line 28. This is your AMTI, which forms the basis for determining your AMT liability.
• Apply Exemption Amount: Compare the amount on line 28 with the exemption amount on line 29. If the amount on line 28 is less, you are exempt from the AMT. If the amount on line 28 is more, you must continue to Part II.
• Calculate Tentative Minimum Tax (TMT): Enter the appropriate amounts on lines 30 to 35 of Form 6251 to calculate your TMT. This is the minimum amount of tax you owe under the AMT rules.
• Calculate Tax on Capital Gains (if applicable): If you have capital gains, complete Part III of Form 6251 to calculate the tax on them.
• Enter Capital Gains Information: Enter the capital gains information on lines 36 to 54 of Form 6251. This information is used to calculate the tax on your capital gains under the AMT rules.

How to File Form 6251 with the IRS?

Filing Form 6251 with the IRS involves several steps. Here is a breakdown of the entire process:

1. Gather Necessary Documents: Before you start, make sure you have all the necessary documents. This includes W-2s, 1099s, and any other forms reporting your income.
2. Download Form 6251: You can download the Form 6251 PDF on your desktop or laptop directly from the IRS website. To avoid any issues, ensure you have the recent version of the form.
3. Complete the Form:
   • Part I – Alternative Minimum Taxable Income (AMTI): Start by calculating your AMTI. This section requires you to make adjustments to your taxable income by adding or subtracting specific items.
   • Part II – Alternative Minimum Tax (AMT): Once you have your AMTI, you will calculate your tentative minimum tax and then your AMT. This means using the correct tax rates and then reducing the amount you owe in regular taxes.
   • Part III – Tax Computation Using Maximum Capital Gains Rates: If applicable, this section involves calculating your tax based on capital gains rates.
4. Double-Check Your Information: Ensure all entries are accurate. Errors can lead to delays, additional scrutiny from the IRS, and potential penalties.
5. Submit Your Form: Attach Form 6251 to your regular tax return (Form 1040) and submit it to the IRS. You can file electronically or mail a paper return.
6. Pay Any Due Tax: If the AMT results in additional tax liability, ensure you make the payment by the tax filing deadline.

The Connection Between Form 6251 and Form 1040

Form 1040 is the primary tax return form for individuals in the United States. It encompasses all your income, deductions, credits, and tax payments to determine your regular tax liability. However, the tax code requires certain high-income earners to calculate their taxes under the AMT system, which is where Form 6251 comes into play.

Let's explore the connection between both these forms:

• Calculating Alternative Minimum Taxable Income (AMTI): When you complete Form 1040, you calculate your taxable income based on regular tax rules. Form 6251 then requires adjustments to this income to determine your AMTI. These adjustments can include adding back certain deductions and income that are not allowed under AMT rules.
• Determining AMT Liability: After calculating your AMTI on Form 6251, you compute your tentative minimum tax. If this amount is higher than your regular tax liability calculated on Form 1040, the difference is your AMT liability. This ensures that you pay the greater of your regular tax or the AMT.
• Reporting AMT on Form 1040: Once you determine your AMT liability using Form 6251, you report this amount on Form 1040, specifically on line 46. This ensures that your total tax liability reflects the higher amount between your regular tax and AMT.

Errors in either form can lead to incorrect tax calculations, resulting in overpayment or underpayment of taxes. Overpayment ties up your capital unnecessarily, while underpayment can lead to penalties and interest charges.

Conclusion

Understanding Form 6251 and AMT is crucial, especially for startup founders dealing with equity compensation. The complexities of these tax matters can be daunting, and professional advice is often necessary.

At Qapita, we recognize these challenges. Our Equity Management Software is rated as #1 by G2 and is optimized to simplify the equity matters for your company. We offer a comprehensive solution for managing ownership, streamlining equity workflows, and providing a structured marketplace for liquidity. Trusted by over 2,400+ companies and 300,000 employee-owners, we aim to make every equity owner count.

Whether you're grappling with Employee Stock Ownership Plans (ESOPs), capitalization tables (CapTables), or tax-related matters like the AMT, Qapita is here to help. Our in-house experts can provide the guidance and support you need. Contact us today to learn more.