Alternative Minimum Tax

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The Alternative Minimum Tax (AMT) system is part of the federal income tax system in the United States. There are two AMTs, one for individuals and the other for corporations. The AMT for individuals is addressed here.

The AMT is, in effect, a parallel tax system imposed under 26 U.S.C. § 55 that disallows many deductions and exemptions allowable in computing "regular" tax liability. (Regular tax liability is defined in 26 U.S.C. § 26(b), and does not include the alternative minimum tax and various other categories of taxes imposed under Chapter 1 of Subtitle A of the Internal Revenue Code.) The AMT was introduced by the Tax Reform Act of 1969,^[1] and became operative in 1970. It was intended to target 155 high-income households that had been eligible for so many tax benefits that they owed little or no income tax under the tax code of the time.^[2]

In recent years, the AMT has become the subject of increased attention. Because the AMT is not indexed to inflation and recent tax cuts,^[3][4] an increasing number of middle-income taxpayers have been finding themselves subject to this tax.

In essence, the AMT sets a minimum tax rate of 25 to 27 percent on taxpayers so that they cannot use many types of deductions to lower their tax. The AMT affects taxpayers who have what are known as "tax preference items". These include, among other things, long-term capital gains, accelerated depreciation, certain medical expenses, percentage depletion, certain tax-exempt income, certain credits, personal exemptions, and the standard deduction.

In 2006, the IRS's National Taxpayer Advocate's report highlighted the AMT as the single most serious problem with the tax code. The advocate noted that the AMT punishes taxpayers for having children or living in a high-tax state, and that the complexity of the AMT leads most taxpayers who owe AMT not realizing it until preparing their returns or being notified by the IRS. [6]

In a brief issued by the Congressional Budget Office (CBO) (No. 4, April 15, 2004),^[5] the conclusion is clear:

Over the coming decade, a growing number of taxpayers will become liable for the AMT. In 2010, if nothing is changed, one in five taxpayers will have AMT liability and nearly every married taxpayer with income between $100,000 and $500,000 will owe the alternative tax. Rather than affecting only high-income taxpayers who would otherwise pay no tax, the AMT has extended its reach to many upper-middle-income households. As an increasing number of taxpayers incur the AMT, pressures to reduce or eliminate the tax are likely to grow.

However, CBO's rules^[6] state that it must use current law in its analysis and at the time of the above text was written, the AMT threshold was set to expire in 2006 and be reset to far lower values.^[7]

[edit] Basic structure of the tax

Example of level of AMT (in absolute and relative terms on top and bottom) in 2000 and 2004 (orange and blue respectively) for a married couple who are filing jointly. The dashed line on the top show the narrow margin between the AMT and current 2004 tax rate, which means that not many deductions are needed before the AMT must be payed.

In addition to the normal tax code calculations, the AMT system uses a different set of rules for determining taxable income and allowable deductions, and uses a simple 26/28% rate calculation to determine the "Tentative Minimum Tax" (TMT). The TMT is compared to the income-tax amount calculated for the taxpayer.

If the regular income-tax amount is greater than the TMT, no special action is required.

If the TMT is greater than the tax calculated using the regular rules, the difference between the TMT and the regular tax is added to the regular tax amount, so the taxpayer pays the full amount of the TMT (although some of that tax is considered regular tax and some is considered AMT).

The portion of the tax that is considered AMT may be available in later years as a "Minimum Tax Credit", reducing the regular income tax due in later years, but not below the taxpayer's TMT level in those later years.

[edit] Criticisms of the tax

Critics of the AMT argue that it suffers from various flaws:

• The AMT is not indexed with inflation, which leads to a lower real cutoff as time goes by.
  • The Congressional Budget Office estimates that in 2006 34.6% of taxpayers in the $50,000 to $100,000 AGI range will owe AMT.^[8], and 11 percent of all tax payers will owe the AMT.
  • The IRS estimates that by 2010, 34% of all individual filers who pay income tax will be subject to the AMT.

• Determining if one is subject to the AMT is complex. According to the IRS, some can not determine whether they owe AMT taxes without: [7]
  • Completing a 16 line worksheet.
  • Reading 9 pages of instructions.
  • Completing a 55 line form.

• For those who earn substantial amounts of money from nonlabor income, AMT is not a tax on long run profits, but a tax on within-year profits only. For example, if you have a prior year loss from stock trades, you cannot use them for AMT. Regular tax calculation allows you to offset prior year losses with current year gains, which would allow long-run profit accounting.

• AMT causes market distortion in capital markets. For example, if an asset (stock or bond) holder would pay less in taxes than they would lose in value if they were to hold a losing stock until they can balance the sale of the money-losing stock with the sale of a money-making stock during the same tax year. This leads to inefficiency in the asset markets that leads to inefficient distribution of capital among companies.^{[citation needed]}

• Like all taxes on investment, the AMT can reduce investment in companies by increasing the capital gains tax.^{[citation needed]} This, in turn, can reduce job creation. This may be offset, if not entirely, because in a country with a debt, all taxes also increase private sector investment by decreasing the amount of invested money tied up in bonds.^{[citation needed]}

[edit] Arguments against repealing the AMT

While almost all parties agree that the AMT needs to be changed, some argue against its outright repeal. The Center on Budget and Policy Priorities states that because households with annual incomes above $200,000 are the source of more than half of all AMT revenue, more than half of the benefits of repeal would go to high-income households. In addition, they state the cost of repeal is prohibitive, with a loss of between $800 billion and $1.5 trillion in federal revenues over 10 years.^[9] In addition, the Tax Policy Center claims that repeal of the AMT would be more expensive than repeal of the income tax.^[10]

[edit] Recent attention on AMT

After the stock revaluations of year 2000 to year 2002, the San Jose Mercury News and San Francisco Chronicle ran a series of newspaper articles about people who were surprised to have to pay the AMT. Featured were employees who had stock options and exercised those options. By the time the employees sold the stock, the stock had dropped by 80% to 100%. One woman was worried about the IRS foreclosing on her home. Another engineer who worked at Rambus, Inc. had exercised his stock options near $400 per share but actually sold the shares at less than his purchase price. He wound up owing the IRS more than a million dollars and committed suicide.^[11]

[edit] Complexity and unintended consequences

The AMT amounts to a flat tax of about 27% on adjusted gross income over $175,000 contains far fewer loopholes. However, taxpayers must also perform all of the paperwork for a regular tax return and then all of the paperwork for Form 6251. The definitions of taxable income, deductible expenses, and exemptions differ on Form 6251 from those on Form 1040.

[edit] The AMT and taxpayer incomes

The AMT's failure to index for inflation is widely conceded as a flaw across the political spectrum. In 2005, the Urban-Brookings Tax Policy Center and the Treasury Department estimated that around 15% of households with incomes between $75,000 and $100,000 must pay the AMT, up from only 2-3% in 2000, with the percentage increasing at high incomes. That percentage is set to increase quickly over the coming years if no change is made such as indexing for inflation. Currently, households with incomes below $75,000 are subject to the AMT only very rarely (and thus most tax advisors do not recommend computing AMT for such households). That is set to change in only a few years, however, if the AMT remains unindexed.

The median household income in the United States was $44,389 in 2005, and households making over $75,000 per year made up the top quartile of household incomes. Since those are the households generally required to compute the AMT (though only a fraction currently have to pay), some argue that the AMT still hits only the wealthy or the upper middle class. However, some counties, such as Fairfax County, VA ($88,133), and some cities, such as San Jose, CA ($71,765), have local median incomes that approach or exceed the typical AMT threshold, which is considerably higher than the national median. The cost of living is generally higher in such areas, which leads to families that are "middle class" for their area having to pay the AMT, while in poorer locales with lower costs of living only the "locally wealthy" pay the AMT. In other words, many who pay the AMT have incomes that would place them among the wealthy when considering the United States as a whole, but who think of themselves as "middle class" because they are not wealthy by the standards of their locale.

The burden of computing the AMT and the disallowance of deductions for state and local income taxes magnify criticisms of the AMT. The deduction for state and local taxes in the normal income tax code can encourage wealthy areas to raise taxes and, in effect, redirect monies that would normally go to the federal government (and hence to residents of poorer states) to their state and local governments, where it can be spent on their own citizens. The AMT would remove this theoretical incentive for wealthy states to increase their state and local taxes, and makes it more likely that citizens of areas with high costs of living will subsidize citizens of areas with lower costs of living.

More and more individual taxpayers are falling into what is being called the "AMT" trap. For many taxpayers, the common question is, "How do I avoid AMT"? The simple answer is to have less tax preference deductions on your Schedule A. The biggest tax preference item on your Schedule A is state income taxes and real estate taxes. In any given year, if your Alternative Minimum Taxable Income (AMTI) is greater than your Regular Taxable Income, you may want to push your last real estate tax payment and state estimated taxes into the upcoming year. If the upcoming year is projected to have more income than the current year you should do it since there would be no tax benefit in the current anyway.

[edit] Notes