California’s tax system is complex, and for certain taxpayers, the Alternative Minimum Tax (AMT) can add an extra layer of financial obligation. California’s AMT operates alongside the state’s standard income tax. It employs a separate calculation that disallows many common deductions. If your income exceeds certain thresholds or includes specific tax preferences—such as incentive stock options or accelerated depreciation—you may be subject to this alternative tax. Unlike the federal AMT, which applies to businesses as well as individual taxpayers, California’s AMT applies only to individuals.
Consider working with a financial advisor to help you plan out your finances for potential taxes you may owe.
What Is the California Alternative Minimum Tax?
The California Alternative Minimum Tax is a parallel tax system designed to ensure that individuals with high incomes or substantial deductions pay a minimum level of state income tax. Unlike the standard income tax calculation, the AMT applies a separate set of rules that disallow many common deductions and tax breaks. In action, this often increases a taxpayer’s overall liability. It primarily impacts those with significant capital gains, incentive stock options or large deductions that significantly reduce taxable income under the regular system.
Not all taxpayers are subject to the AMT, but certain financial activities increase the likelihood of triggering it. Those who exercise incentive stock options, claim large deductions for state and local taxes or benefit from accelerated depreciation on business assets may fall within the AMT’s scope. High-income earners and individuals with substantial passive income, such as rental property gains, may also need to calculate their tax liability under this system.
Being aware of the California AMT can help taxpayers plan and avoid unexpected tax bills. Since the state’s AMT calculation differs from the federal version, even those who are not subject to the federal AMT could still owe additional tax at the state level. Consulting with a tax professional or using tax software that accounts for AMT adjustments can help individuals determine whether they are affected and explore strategies to minimize their tax liability.
California AMT vs. Federal AMT
The biggest difference the California and federal AMT systems is that California’s AMT covers only individuals, while the federal AMT also applies to businesses. Beyond that, a major difference is how they apply income exemption thresholds.
The federal AMT has been significantly adjusted in recent years, particularly after the Tax Cuts and Jobs Act (TCJA) of 2017 increased exemption thresholds and reduced the number of taxpayers affected. California, however, has maintained its own AMT system with lower exemption amounts, meaning taxpayers may be subject to the state’s AMT even if they no longer owe federal AMT.
The federal AMT uses a two-tiered tax rate structure—26% and 28%—that applies based on income levels. In contrast, California’s AMT applies a flat 7% rate on the alternative minimum taxable income (AMTI), which is determined by making adjustments to the regular state taxable income. These adjustments often disallow certain deductions, such as state and local tax deductions, that might have otherwise lowered a taxpayer’s overall burden.
Both tax systems restrict the use of various deductions and credits, but the specifics vary. At the federal level, the AMT calculation eliminates or limits deductions such as state and local taxes, medical expenses and miscellaneous itemized deductions. California’s AMT disallows many of the same deductions but has additional adjustments unique to the state, such as modifications to depreciation schedules and adjustments for net operating losses.
Additionally, while the federal AMT allows a credit for AMT paid in previous years, California’s AMT credit system is more limited and does not always provide the same relief. Because California’s AMT system is separate from the federal AMT, taxpayers may find themselves owing state AMT even if they are not subject to federal AMT.
Who Must Pay California’s AMT?
Not every taxpayer is required to pay the California AMT. The tax primarily affects individuals who benefit from tax preferences that significantly reduce their regular taxable income. These taxpayers must calculate their tax liability under both the standard system and the AMT rules and then pay the higher amount.
California’s AMT often applies to high-income earners, particularly those whose adjusted gross income exceeds certain thresholds. Unlike the federal AMT, which has seen exemptions increase significantly in recent years, California maintains lower exemption amounts, meaning more taxpayers are affected.
One of the most common triggers for California’s AMT is the exercise of incentive stock options (ISOs). While these options are not immediately taxable under the regular income tax system, they are considered taxable income under AMT rules. Similarly, large capital gains from the sale of assets can increase the alternative minimum taxable income (AMTI), leading to a higher likelihood of AMT liability.
How To Calculate California’s AMT
The first step in calculating California’s AMT is determining the AMTI by making adjustments to regular taxable income. Certain deductions and tax preferences, such as incentive stock options, accelerated depreciation, and net operating losses, must be added back to income under AMT rules. These adjustments can significantly increase taxable income, making it more likely that a taxpayer will owe AMT.
California provides an AMT exemption amount that reduces the taxable base, but it phases out at higher income levels. The exemption varies depending on filing status, with married couples and heads of household receiving a higher exemption than single filers. If a taxpayer’s income exceeds the phase-out threshold, the exemption is gradually reduced, increasing the likelihood of paying AMT.
Once AMTI is determined and the exemption is applied, the remaining taxable amount is subject to California’s AMT rate of 7%. This tax is then compared to the standard state income tax calculated under regular rules. If the AMT amount is higher, the taxpayer must pay the difference as additional tax. Unlike the federal AMT, California does not provide as many opportunities for AMT credits in future years, making it essential for taxpayers to plan accordingly.
Bottom Line
California’s AMT operates alongside the regular state income tax, similar to the federal AMT but with some important differences. The tax primarily affects high-income earners and individuals with certain deductions or tax preferences, such as incentive stock options or accelerated depreciation. Because the California AMT is different from the federal AMT, taxpayers who do not fall under the federal AMT guidelines may still owe tax under California’s AMT system.
Tips for Tax Planning
- A financial advisor can help with your ability to prepare for potential tax liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s Tax Return Calculator can give you an estimate of how much you’re likely to owe or receive as a refund when you file your next return.
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