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 was introduced by the Tax Reform Act of 1969,^[1] and became operative in 1970. It was originally intended to target very high incomes which were subject to many exemptions under the mainstream tax code of the time. The AMT was substantially changed by the Revenue Act of 1978,^[2] significant provisions of which (with respect to the AMT for individuals) are codified at Internal Revenue Code sections 55(a) and 55(b)(1) (see 26 U.S.C. § 55), effective for tax years that began after December 31, 1978.

In essence, the intention of the AMT is to set a minimum tax rate of about 27% on the highest earning tax payers so that they can not use loop holes or other tax reduction strategies to entirely avoid paying a substantial amount of income tax. The AMT affects taxpayers who have what are known as "tax preference items." These include (among others) long term capital gains, accelerated depreciation, percentage depletion, and certain tax-exempt income, which are all considered to have favorable tax treatment and could trigger the alternative minimum tax. Numerous tax credits can also trigger the AMT.

In a brief issued by the Congressional Budget Office (No. 4, April 15, 2004),^[3] the conclusion was 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.

Contents 1 Basic structure of the tax 2 Criticisms of the tax 2.1 Recent Attention on AMT 2.2 Complexity and Unintended Consequences 2.3 The AMT and taxpayer incomes 3 Politics and the AMT 4 Notes

[edit] Basic structure of the tax

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 which is considered AMT may be available in later years as a "Minimum Tax Credit", reducing the regular income tax due in later years, but only to 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 does not change with inflation, leading to a lower cutoff as time goes by. While still focusing primarily on people in the 99.8th percentile who earn more than a million dollars per year, there are people above the 97th percentile of income that are also affected ^[4]. While earning substantially more than the median American, some consider themselves to be middle-class by the standards of areas with high cost of living.

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

• AMT causes market distortion in capital markets. For example, if an asset (stock or bond) holder would pay less taxes than they would lose in value if they were to hold a losing stock until you 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.

• Like all taxes on investment, the AMT reduces investment in companies by increasing the capital gains tax. This, in turn, reduces job creation. This is 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.

[edit] Recent Attention on AMT

After the stock market crash of year 2000 to year 2002, the San Jose Mercury News and San Francisco Chronicle ran a series of newpaper articles about people who were caught by Alternative Minimum Tax. 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.^{[citation needed]}

[edit] Complexity and Unintended Consequences

The AMT amounts to a flat tax of about 27% on high wage earners and contains far fewer loopholes. However, tax payers must also perform all paperwork for a regular tax return and then Form 6251. The definitions of taxable income, deductible expenses, and exemptions differ on Form 6251 than those on Form 1040.

[edit] The AMT and taxpayer incomes

The lack of indexing 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 Alternative Minimum Tax, 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 only very rarely subject to AMT (and thus most tax advisors do not recommend computing AMT for such households), but that is set to change in only a few years if no indexing is done.

The median household income in the United States was $44,389 in 2005, and households making over $75,000 per year make 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 which are near or exceed the typical AMT threshold (making them much higher than the national median). The cost of living is generally higher in those areas, leading to families which are "middle class" for their area having to pay AMT, while in poorer locales with lower cost of living still only the "locally wealthy" pay AMT. In other words, many who pay the AMT have incomes which would place them among the wealthy when considering the United States as a whole, but prefer to think of themselves as "middle class" because they are not particularly more wealthy than their immediate neighbors.

The burden of computing 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.

[edit] Politics and the AMT

The AMT disportionately affects those who live in wealthier areas with higher cost of living and areas with higher state and local taxes, areas which are primarily represented by Democrats. Thus, many Democrats favor a tax reform of the AMT that would benefit primarily those who would be objectively viewed as wealthy by the standard of the country as a whole or their incomes, although they only live what they, themselves, like to call "a middle class lifestyle". Some Republicans wish to package AMT reform together with extensions of other tax cuts, which Democrats in general oppose.

The Joint Committee on Taxation reports that indexing for inflation would explode the deficit by $370 billion over the next several years. [1] The Center on Budget and Policy Priorities states repealing the AMT, without other tax increasess to make up the shortfall, would add $1.2 trillion to the deficit, and widening over the next decade, with deficits as far as the eye can see. [2] To put that in perspective, total revenues to the U.S Government in FY 2006 were $2.4 trillion.

In 2006, 3.8 million taxpayers are expected to be subject to the Alternative Minimum Tax. By 2007, the figure is projected to balloon to 23 million--nearly one in six workers. [3]

[edit] Notes