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Introduction
1. Preliminary work to prepare tax returns
2. Taxability of income
3. Retirement, investment, and supplemental income
4. Deductions
5. Credits
6. Taxation
6.1 Alternative tax and retirement rules
6.2 Tax payments, credits, and adjustments
7. Advising the individual taxpayer
8. Specialized returns
Wrapping up
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6.1 Alternative tax and retirement rules
Achievable IRS EA Part 1
6. Taxation

Alternative tax and retirement rules

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Alternative minimum tax

The U.S. federal income tax system is progressive, meaning it imposes higher marginal tax rates on individuals with higher taxable incomes, with rates currently ranging from 10% to 37% (Source: IRS.gov). This structure ensures that taxpayers with greater income pay a larger percentage of their earnings in taxes, often referred to as the “ability to pay” principle. The alternative minimum tax (AMT) is a separate income tax system that is designed to ensure that taxpayers who take advantage of certain tax-advantaged items and deductions pay a minimum amount of tax. The tax advantaged items are the adjustments and preference items (certain deductions and exclusions) that are added back to taxable income to figure alternative minimum taxable income (AMTI); the AMT exemption amount ($88,100 single, $137,000 married filing jointly for 2025) is then subtracted, and AMT is owed only if the tentative minimum tax is more than the regular tax. Among itemized deductions, state and local taxes are added back (Form 6251, line 2a; a taxpayer who doesn’t itemize adds back the standard deduction), while interest on a loan used to buy, build, or substantially improve the taxpayer’s home stays deductible.

Major adjustments and preference items are:

  • Interest on private activity municipal bonds
  • Accelerated depreciation
  • Income from exercising incentive stock options
  • Excess intangible drilling costs for oil and gas
  • 7% of the gain excluded on qualified small business stock (section 1202), but only for stock acquired before September 28, 2010; the exclusion for stock acquired later isn’t a preference item

The complete list of tax advantaged items is shown on IRS Form 6251. Charitable contributions aren’t on it: they generally stay deductible for AMT just as they are for regular tax.

Definitions
Alternative minimum tax (AMT)
A parallel tax system with rates of 26% and 28%, designed to ensure that high-income taxpayers who benefit from certain deductions and exclusions still pay a minimum level of federal income tax. Taxpayers owe whichever is higher - their regular tax or their AMT.
Adjustments and preference items
The items that are refigured or added back to taxable income when calculating the AMT. Adjustments refigure an item under AMT rules, such as the incentive stock option spread at exercise or depreciation on property placed in service after 1986; preferences, such as interest on private activity bonds, are added back.
Private activity municipal bonds
Tax-exempt bonds issued to finance projects that serve private interests but provide some public benefit. While the interest is generally exempt from regular income tax, it is a preference item that may trigger the AMT.
Incentive stock options (ISOs)
A type of employee stock option that qualifies for favorable tax treatment. The spread between the exercise price and the market value at the time of exercise is not subject to regular income tax but is an AMT adjustment (Form 6251, line 2i) in the year of exercise, unless the stock is sold that same year.

Credit for prior year minimum tax

This credit allows taxpayers who had paid the alternative minimum tax (AMT) in a prior year to recover the payment up to the difference between the regular and AMT tax. Only AMT caused by deferral items, such as depreciation adjustments or exercising incentive stock options, which reverse in later years, creates the credit; AMT caused by exclusion items, such as the standard deduction, state and local taxes, or tax-exempt private activity bond interest, does not. Exceptions apply; a portion of the credit can be carried forward to future years. Form 8801 is used to claim the credit. Review the Form 8801 instructions for more information.

Net investment income tax

The net investment income tax (NIIT) is a 3.8% tax on the investment income of higher-income individuals, estates, and trusts. An individual owes 3.8% of the lesser of:

  • Net investment income (NII), or
  • The amount by which modified adjusted gross income (MAGI) exceeds the threshold for the taxpayer’s filing status.

For NIIT purposes, MAGI is generally AGI increased by any excluded foreign earned income, so for most taxpayers it equals AGI. The thresholds are set by statute and are not indexed for inflation:

  • $250,000 for married filing jointly or qualifying surviving spouse
  • $200,000 for single or head of household
  • $125,000 for married filing separately

Included in NII: interest, dividends, capital gains (including gain on the sale of a main home above the excluded amount, and gain on a second home), rents and royalties, nonqualified annuities, and income from passive activities or from trading financial instruments or commodities. Investment expenses properly allocable to that income reduce it.

Not NII: wages, self-employment income, operating income from a nonpassive business, unemployment compensation, Social Security benefits, alimony, tax-exempt interest, the excluded gain on the sale of a main home, and distributions from qualified retirement plans and IRAs, including Roth IRAs.

The tax is figured on Form 8960 and reported on Schedule 2 (Form 1040), line 12.

Example: Net investment income tax

Lena is single. Her 2025 MAGI is $230,000: $190,000 of wages and $40,000 of interest, dividends, and long-term capital gains.

  • Net investment income: $40,000
  • MAGI over the threshold: $230,000 − $200,000 = $30,000
  • The lesser amount: $30,000
  • NIIT: $30,000 × 3.8% = $1,140

Answer: Lena owes $1,140 of NIIT, figured on Form 8960. Her wages are not NII, but they count toward the MAGI that is compared with the threshold.

Estimated tax

The U.S. tax system is pay-as-you-go, meaning tax is expected to be paid throughout the year as income is earned or received, through withholding or estimated payments. To avoid an underpayment penalty, a taxpayer generally must pay at least 90% of the current year’s tax or meet one of the safe harbor amounts described below. Taxpayers whose income sources are not subject to withholding must pay estimated taxes on that income in quarterly payments.

The calendar year due dates are as follows:

  • April 15 (January, February, March)
  • June 15 (April, May)
  • September 15 (June, July, August)
  • January 15, next year (September, October, November, December)

The following qualify as payments of estimated tax:

  • Overpayments of tax in a prior year which has not been refunded to the following year’s tax return
  • Amount of federal tax withholding from wages
  • Direct payment by the taxpayer or by someone on behalf of the taxpayer

Excess social security tax withholding also counts toward estimated tax: like income tax withholding, it is treated as paid in equal parts on each installment due date. It occurs when an employee has two or more employers during a tax year and, combined, more than the ceiling was withheld on Social Security tax (Medicare tax has no ceiling); the excess is claimed as a refundable credit on Form 1040, Schedule 3.

Each installment must be at least 25% of the required annual payment, which is the lesser of:

  • 90% of the current year’s tax
  • 100% of the prior year’s tax (110% if the safe harbor threshold below applies)

Taxpayers with uneven income during the year can instead use the annualized income installment method, which bases each installment on income actually earned up to that point in the year rather than spreading the annual liability evenly across four payments.

Safe harbor rule
Taxpayers whose prior-year adjusted gross income (AGI) exceeded $150,000 ($75,000 for married filing separately) must use 110% of the prior year’s tax liability as their safe harbor amount; other taxpayers use 100% of the prior year’s tax liability.

Definitions
Safe harbor rule
A provision that protects taxpayers from underpayment penalties if they pay a specified minimum amount of estimated tax. For most taxpayers, the safe harbor requires paying 100% of the prior year’s tax liability, or 110% if AGI exceeded $150,000 ($75,000 for married filing separately).

Penalty for underpayment of estimated tax
A penalty, figured at the federal short-term rate plus 3 percentage points, applies to each required installment not paid in full by its due date, on the underpaid amount for the period it stays unpaid. The taxpayer can figure it on Form 2210 or leave it to the IRS, which will figure the penalty and send a bill; the rate is set by law each quarter, not chosen on the form.

No underpayment penalty applies if any of the following is true:

  • The tax shown on the return minus withholding (and refundable credits) is less than $1,000
  • No tax liability on the prior year’s tax return
  • The IRS waives it for a casualty, disaster, or other unusual circumstance, or if the taxpayer retired after age 62 or became disabled and the underpayment was due to reasonable cause.

Farmers and fishermen who expect to receive at least two-thirds of their gross income from farming or fishing activities or did so during the prior year may pay their estimated tax in one installment.

Premature distribution from retirement plans

Taxpayers under 59½ years of age will owe a 10% additional tax on the taxable portion of a distribution from a qualified retirement plan, in addition to regular income tax on that amount. There are exceptions that apply. For the full list and descriptions, see the IRS retirement plan early distribution exceptions for more information. To see how the exceptions are applied on a tax return, see Form 5329. Note that the penalty is not reduced by child care, children, education, other credits, etc., on the 1040 tax return.

Separately, retirement account owners who reach the required minimum distribution (RMD) age and fail to withdraw the full RMD owe an excise tax of 25% of the shortfall, reduced to 10% if the shortfall is corrected within the statutory correction window. This failure-to-take penalty is also reported on Form 5329.

Alternative minimum tax (AMT)

  • Parallel tax system (rates 26%/28%); ensures high-income taxpayers with preference items pay minimum tax
  • Taxpayer owes higher of regular tax or AMT
  • AMTI = taxable income + preference items/adjustments; the exemption ($88,100 single/$137,000 MFJ for 2025) is then subtracted from AMTI
  • Key adjustments and preference items: private activity bond interest, accelerated depreciation, ISO spread at exercise (an adjustment), excess intangible drilling costs, 7% of the section 1202 exclusion on small business stock acquired before September 28, 2010
  • Full list on IRS Form 6251

Credit for prior year minimum tax

  • Recovers AMT paid in prior year, up to difference between regular and AMT tax
  • Unused credit can carry forward
  • Claimed on Form 8801

Net investment income tax (NIIT)

  • 3.8% tax on lesser of: net investment income (NII) or MAGI over threshold
  • Thresholds (not inflation-indexed): $250,000 MFJ/QSS, $200,000 single/HOH, $125,000 MFS
  • MAGI ≈ AGI for most taxpayers
  • NII includes: interest, dividends, capital gains, rents/royalties, nonqualified annuities, passive activity income
  • Not NII: wages, self-employment income, Social Security, retirement plan/IRA distributions, excluded home sale gain
  • Reported on Form 8960, Schedule 2 line 12

Estimated tax

  • Pay-as-you-go system; avoid penalty by paying 90% of current year tax or safe harbor amount
  • Quarterly due dates: April 15, June 15, Sept 15, Jan 15 (next year)
  • Qualifying payments: prior-year overpayment applied forward, withholding, direct estimated payments, excess Social Security withholding
  • Each installment ≥25% of required annual payment (lesser of 90% current year or 100%/110% prior year)
  • Safe harbor: 110% of prior year tax if prior AGI >$150,000 ($75,000 MFS); otherwise 100%
  • Annualized income installment method available for uneven income
  • Underpayment penalty: federal short-term rate + 3%
  • No penalty if: tax minus withholding (and refundable credits) <$1,000, or no prior-year tax liability; IRS may waive it (casualty/disaster, or retired after age 62 or became disabled, with reasonable cause)
  • Farmers/fishermen (2/3 of gross income from farming/fishing): may pay estimated tax in one installment

Premature distribution from retirement plans

  • 10% additional tax on taxable portion of distributions before age 59½ (plus regular income tax)
  • Exceptions listed by IRS; applied via Form 5329
  • Penalty not reduced by credits (child care, education, etc.)
  • Missed RMDs: 25% excise tax on shortfall, reduced to 10% if corrected within correction window
  • Both penalties reported on Form 5329

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Alternative tax and retirement rules

Alternative minimum tax

The U.S. federal income tax system is progressive, meaning it imposes higher marginal tax rates on individuals with higher taxable incomes, with rates currently ranging from 10% to 37% (Source: IRS.gov). This structure ensures that taxpayers with greater income pay a larger percentage of their earnings in taxes, often referred to as the “ability to pay” principle. The alternative minimum tax (AMT) is a separate income tax system that is designed to ensure that taxpayers who take advantage of certain tax-advantaged items and deductions pay a minimum amount of tax. The tax advantaged items are the adjustments and preference items (certain deductions and exclusions) that are added back to taxable income to figure alternative minimum taxable income (AMTI); the AMT exemption amount ($88,100 single, $137,000 married filing jointly for 2025) is then subtracted, and AMT is owed only if the tentative minimum tax is more than the regular tax. Among itemized deductions, state and local taxes are added back (Form 6251, line 2a; a taxpayer who doesn’t itemize adds back the standard deduction), while interest on a loan used to buy, build, or substantially improve the taxpayer’s home stays deductible.

Major adjustments and preference items are:

  • Interest on private activity municipal bonds
  • Accelerated depreciation
  • Income from exercising incentive stock options
  • Excess intangible drilling costs for oil and gas
  • 7% of the gain excluded on qualified small business stock (section 1202), but only for stock acquired before September 28, 2010; the exclusion for stock acquired later isn’t a preference item

The complete list of tax advantaged items is shown on IRS Form 6251. Charitable contributions aren’t on it: they generally stay deductible for AMT just as they are for regular tax.

Definitions
Alternative minimum tax (AMT)
A parallel tax system with rates of 26% and 28%, designed to ensure that high-income taxpayers who benefit from certain deductions and exclusions still pay a minimum level of federal income tax. Taxpayers owe whichever is higher - their regular tax or their AMT.
Adjustments and preference items
The items that are refigured or added back to taxable income when calculating the AMT. Adjustments refigure an item under AMT rules, such as the incentive stock option spread at exercise or depreciation on property placed in service after 1986; preferences, such as interest on private activity bonds, are added back.
Private activity municipal bonds
Tax-exempt bonds issued to finance projects that serve private interests but provide some public benefit. While the interest is generally exempt from regular income tax, it is a preference item that may trigger the AMT.
Incentive stock options (ISOs)
A type of employee stock option that qualifies for favorable tax treatment. The spread between the exercise price and the market value at the time of exercise is not subject to regular income tax but is an AMT adjustment (Form 6251, line 2i) in the year of exercise, unless the stock is sold that same year.

Credit for prior year minimum tax

This credit allows taxpayers who had paid the alternative minimum tax (AMT) in a prior year to recover the payment up to the difference between the regular and AMT tax. Only AMT caused by deferral items, such as depreciation adjustments or exercising incentive stock options, which reverse in later years, creates the credit; AMT caused by exclusion items, such as the standard deduction, state and local taxes, or tax-exempt private activity bond interest, does not. Exceptions apply; a portion of the credit can be carried forward to future years. Form 8801 is used to claim the credit. Review the Form 8801 instructions for more information.

Net investment income tax

The net investment income tax (NIIT) is a 3.8% tax on the investment income of higher-income individuals, estates, and trusts. An individual owes 3.8% of the lesser of:

  • Net investment income (NII), or
  • The amount by which modified adjusted gross income (MAGI) exceeds the threshold for the taxpayer’s filing status.

For NIIT purposes, MAGI is generally AGI increased by any excluded foreign earned income, so for most taxpayers it equals AGI. The thresholds are set by statute and are not indexed for inflation:

  • $250,000 for married filing jointly or qualifying surviving spouse
  • $200,000 for single or head of household
  • $125,000 for married filing separately

Included in NII: interest, dividends, capital gains (including gain on the sale of a main home above the excluded amount, and gain on a second home), rents and royalties, nonqualified annuities, and income from passive activities or from trading financial instruments or commodities. Investment expenses properly allocable to that income reduce it.

Not NII: wages, self-employment income, operating income from a nonpassive business, unemployment compensation, Social Security benefits, alimony, tax-exempt interest, the excluded gain on the sale of a main home, and distributions from qualified retirement plans and IRAs, including Roth IRAs.

The tax is figured on Form 8960 and reported on Schedule 2 (Form 1040), line 12.

Example: Net investment income tax

Lena is single. Her 2025 MAGI is $230,000: $190,000 of wages and $40,000 of interest, dividends, and long-term capital gains.

  • Net investment income: $40,000
  • MAGI over the threshold: $230,000 − $200,000 = $30,000
  • The lesser amount: $30,000
  • NIIT: $30,000 × 3.8% = $1,140

Answer: Lena owes $1,140 of NIIT, figured on Form 8960. Her wages are not NII, but they count toward the MAGI that is compared with the threshold.

Estimated tax

The U.S. tax system is pay-as-you-go, meaning tax is expected to be paid throughout the year as income is earned or received, through withholding or estimated payments. To avoid an underpayment penalty, a taxpayer generally must pay at least 90% of the current year’s tax or meet one of the safe harbor amounts described below. Taxpayers whose income sources are not subject to withholding must pay estimated taxes on that income in quarterly payments.

The calendar year due dates are as follows:

  • April 15 (January, February, March)
  • June 15 (April, May)
  • September 15 (June, July, August)
  • January 15, next year (September, October, November, December)

The following qualify as payments of estimated tax:

  • Overpayments of tax in a prior year which has not been refunded to the following year’s tax return
  • Amount of federal tax withholding from wages
  • Direct payment by the taxpayer or by someone on behalf of the taxpayer

Excess social security tax withholding also counts toward estimated tax: like income tax withholding, it is treated as paid in equal parts on each installment due date. It occurs when an employee has two or more employers during a tax year and, combined, more than the ceiling was withheld on Social Security tax (Medicare tax has no ceiling); the excess is claimed as a refundable credit on Form 1040, Schedule 3.

Each installment must be at least 25% of the required annual payment, which is the lesser of:

  • 90% of the current year’s tax
  • 100% of the prior year’s tax (110% if the safe harbor threshold below applies)

Taxpayers with uneven income during the year can instead use the annualized income installment method, which bases each installment on income actually earned up to that point in the year rather than spreading the annual liability evenly across four payments.

Safe harbor rule
Taxpayers whose prior-year adjusted gross income (AGI) exceeded $150,000 ($75,000 for married filing separately) must use 110% of the prior year’s tax liability as their safe harbor amount; other taxpayers use 100% of the prior year’s tax liability.

Definitions
Safe harbor rule
A provision that protects taxpayers from underpayment penalties if they pay a specified minimum amount of estimated tax. For most taxpayers, the safe harbor requires paying 100% of the prior year’s tax liability, or 110% if AGI exceeded $150,000 ($75,000 for married filing separately).

Penalty for underpayment of estimated tax
A penalty, figured at the federal short-term rate plus 3 percentage points, applies to each required installment not paid in full by its due date, on the underpaid amount for the period it stays unpaid. The taxpayer can figure it on Form 2210 or leave it to the IRS, which will figure the penalty and send a bill; the rate is set by law each quarter, not chosen on the form.

No underpayment penalty applies if any of the following is true:

  • The tax shown on the return minus withholding (and refundable credits) is less than $1,000
  • No tax liability on the prior year’s tax return
  • The IRS waives it for a casualty, disaster, or other unusual circumstance, or if the taxpayer retired after age 62 or became disabled and the underpayment was due to reasonable cause.

Farmers and fishermen who expect to receive at least two-thirds of their gross income from farming or fishing activities or did so during the prior year may pay their estimated tax in one installment.

Premature distribution from retirement plans

Taxpayers under 59½ years of age will owe a 10% additional tax on the taxable portion of a distribution from a qualified retirement plan, in addition to regular income tax on that amount. There are exceptions that apply. For the full list and descriptions, see the IRS retirement plan early distribution exceptions for more information. To see how the exceptions are applied on a tax return, see Form 5329. Note that the penalty is not reduced by child care, children, education, other credits, etc., on the 1040 tax return.

Separately, retirement account owners who reach the required minimum distribution (RMD) age and fail to withdraw the full RMD owe an excise tax of 25% of the shortfall, reduced to 10% if the shortfall is corrected within the statutory correction window. This failure-to-take penalty is also reported on Form 5329.

Key points

Alternative minimum tax (AMT)

  • Parallel tax system (rates 26%/28%); ensures high-income taxpayers with preference items pay minimum tax
  • Taxpayer owes higher of regular tax or AMT
  • AMTI = taxable income + preference items/adjustments; the exemption ($88,100 single/$137,000 MFJ for 2025) is then subtracted from AMTI
  • Key adjustments and preference items: private activity bond interest, accelerated depreciation, ISO spread at exercise (an adjustment), excess intangible drilling costs, 7% of the section 1202 exclusion on small business stock acquired before September 28, 2010
  • Full list on IRS Form 6251

Credit for prior year minimum tax

  • Recovers AMT paid in prior year, up to difference between regular and AMT tax
  • Unused credit can carry forward
  • Claimed on Form 8801

Net investment income tax (NIIT)

  • 3.8% tax on lesser of: net investment income (NII) or MAGI over threshold
  • Thresholds (not inflation-indexed): $250,000 MFJ/QSS, $200,000 single/HOH, $125,000 MFS
  • MAGI ≈ AGI for most taxpayers
  • NII includes: interest, dividends, capital gains, rents/royalties, nonqualified annuities, passive activity income
  • Not NII: wages, self-employment income, Social Security, retirement plan/IRA distributions, excluded home sale gain
  • Reported on Form 8960, Schedule 2 line 12

Estimated tax

  • Pay-as-you-go system; avoid penalty by paying 90% of current year tax or safe harbor amount
  • Quarterly due dates: April 15, June 15, Sept 15, Jan 15 (next year)
  • Qualifying payments: prior-year overpayment applied forward, withholding, direct estimated payments, excess Social Security withholding
  • Each installment ≥25% of required annual payment (lesser of 90% current year or 100%/110% prior year)
  • Safe harbor: 110% of prior year tax if prior AGI >$150,000 ($75,000 MFS); otherwise 100%
  • Annualized income installment method available for uneven income
  • Underpayment penalty: federal short-term rate + 3%
  • No penalty if: tax minus withholding (and refundable credits) <$1,000, or no prior-year tax liability; IRS may waive it (casualty/disaster, or retired after age 62 or became disabled, with reasonable cause)
  • Farmers/fishermen (2/3 of gross income from farming/fishing): may pay estimated tax in one installment

Premature distribution from retirement plans

  • 10% additional tax on taxable portion of distributions before age 59½ (plus regular income tax)
  • Exceptions listed by IRS; applied via Form 5329
  • Penalty not reduced by credits (child care, education, etc.)
  • Missed RMDs: 25% excise tax on shortfall, reduced to 10% if corrected within correction window
  • Both penalties reported on Form 5329

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