Tax Preference Items and the Alternative Minimum Tax
Understand why certain deductions and income are treated differently under the Alternative Minimum Tax, a parallel calculation of your total tax liability.
Certain elements of income or specific deductions that receive beneficial treatment under standard income tax rules are known as tax preference items. The tax code includes these preferences to encourage economic activities, such as investing in certain municipal projects or business ventures. The purpose of identifying these preference items is to ensure a degree of fairness in the tax system. Lawmakers recognized that without a secondary check, some individuals could use a combination of these favorable deductions and income exclusions to significantly lower, or even eliminate, their tax obligation.
The Role of the Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is a parallel tax system that exists alongside the regular federal income tax. Its purpose is to ensure that individuals with high incomes, who might otherwise use numerous deductions and exclusions, pay at least a minimum amount of tax. The AMT was designed to prevent situations where taxpayers could legally avoid significant tax liability through the extensive use of tax benefits.
The calculation for the AMT starts with a taxpayer’s regular taxable income, which is then re-calculated under a different set of rules. This process involves adding back certain deductions and income exclusions that were allowed for regular tax purposes, including tax preference items. The result of this calculation is the Alternative Minimum Taxable Income (AMTI).
After determining the AMTI, a specific AMT exemption amount is subtracted. For the 2025 tax year, this exemption is $88,100 for single filers and $137,000 for married couples filing jointly. The remaining income is then subject to AMT tax rates of 26% and 28%. A taxpayer must pay whichever amount is higher: their regular tax liability or their tentative minimum tax.
Common Tax Preference Items for Individuals
Several specific income and deduction types are classified as tax preference items for individuals. Common examples include:
- Interest from specified private activity bonds. These are bonds issued by state or local governments to finance projects for a private, non-governmental entity, such as building a sports stadium. While the interest on most municipal bonds is tax-free for regular tax purposes, interest from these specific private activity bonds is a tax preference item.
- The depletion deduction for natural resources. Businesses that extract oil, gas, or minerals are allowed a deduction for depletion. The percentage depletion method allows a deduction calculated as a percentage of the gross income from the property. When this deduction exceeds the taxpayer’s adjusted basis in the property, the excess amount is a tax preference item.
- Intangible drilling costs (IDCs). These are the expenses for drilling and preparing wells for production that lack salvage value, such as labor and fuel. For regular tax purposes, independent producers can deduct these costs immediately, but a portion of these “excess” IDCs is considered a tax preference item for the AMT.
- Exclusion of gain from the sale of Qualified Small Business Stock (QSBS). Taxpayers can often exclude up to 100% of the gain from selling QSBS held for more than five years. For stock acquired on or before September 27, 2010, a portion of the excluded gain is considered a preference item. For QSBS acquired after that date, the exclusion applies to both regular tax and the AMT and is not a preference item.
Distinguishing Adjustments from Preferences
When calculating the Alternative Minimum Tax, both adjustments and preferences are added to regular taxable income, but they are distinct categories. The difference is their directionality. Tax preference items are always positive additions that increase a taxpayer’s Alternative Minimum Taxable Income. They represent income or deductions allowed for regular tax but not for the AMT.
AMT adjustments, however, can be either positive or negative. An adjustment reflects a timing difference in when an income or expense is recognized between the two tax systems. For example, depreciation for certain assets is calculated differently for regular tax and AMT. In an asset’s early years, regular tax depreciation may be larger, creating a positive adjustment, while in later years, AMT depreciation may be larger, resulting in a negative adjustment.
Common adjustments include the standard deduction and deductions for state and local taxes (SALT), which are not permitted for AMT and are added back as positive adjustments. Incentive stock options (ISOs) also create an adjustment, where the difference between the stock’s fair market value and the exercise price is added to AMTI.
Calculating and Reporting on Form 6251
The mechanism for calculating the AMT and reporting tax preference items is IRS Form 6251, Alternative Minimum Tax—Individuals. This form guides taxpayers through the process of re-calculating their income under AMT rules.
Tax preference items are specifically addressed in Part I of Form 6251. Each preference item has its own designated line, such as for interest from private activity bonds or the excess percentage depletion. The form requires the taxpayer to perform the necessary calculations to determine the preference amount for each category before entering it.
Once all individual preference items are listed, they are totaled and combined with the sum of all AMT adjustments. This combined figure is added to the taxpayer’s regular taxable income to compute the initial AMTI. The form then directs the taxpayer through subsequent calculations, including the subtraction of the AMT exemption and the application of the AMT tax rates, to arrive at the tentative minimum tax.