Dr. Martin Regalia: ECON 101
First in a two-part series
The talk on Capitol Hill about the alternative minimum tax, or AMT, has become very lively this year-perhaps more so than in previous years. What's it all about?
The AMT comes in two flavors-individual and corporate. Most of the recent talk involves the individual AMT, which is levied on individuals, estates, and trusts. While it can, therefore, affect businesses whose taxes are imposed on form 1040-including sole proprietors and those with S corporation, partnership, or LLC interests-having reportable business activity is not a prerequisite.
The AMT was enacted to ensure that high-income taxpayers pay some tax. Through the extensive use of tax incentives, some high-income taxpayers can greatly reduce or eliminate their income tax liabilities. The problem is that the AMT does not accomplish what it was designed to do.
Before we get into why the AMT misses the mark, let's take a look at how it works.
Tax benefits realized through certain tax deductions and exemptions are designated "tax preference items" and, together with certain "tax adjustment items," are added back to regular taxable income in arriving at alternative minimum taxable income (AMTI).
For individual taxpayers, AMTI is then reduced by an exemption. For 2006, this was $62,550 for married filing jointly or qualifying widow or widower, $42,500 for single or head of household, and $31,275 for married filing separately.
This recomputed income is the base upon which the AMT is calculated. It is subject to a two-tier tax rate structure. The first tier taxes the first $175,000 ($87,500 for married filing separately) of AMTI in excess of the exemption amount at a 26% rate. The second tier subjects additional AMTI to a 28% rate. However, special rates apply to net long-term capital gains and qualified dividends, and certain tax credits are allowed.
The AMT is then paid to the extent that it exceeds the regularly computed income tax liability.
While these tax preferences and adjustment items can include some portion of business-related deductions, many taxpayers are threatened with AMT because of non-business-related items. The irony is that much of the public was led to believe that the AMT's purpose is to get rich businesspeople to pay some taxes when they may not otherwise.
The AMT is a paperwork nightmare. The 2006 AMT form for individuals is a 55-line, 2-page document with 10 pages of instructions. It has 26 income adjustment lines for computing the AMTI. Many of these adjustments require their own side computations. Numerous taxpayers have to sink considerable time and effort into completing the calculations (or pay their return preparers to do so), only to find that they owe no AMT. This exercise illustrates the vagaries of our Internal Revenue Code and the AMT as a "tax system within a tax system." Think about having to do tax planning for both the regular income tax and the AMT!
How do you go about planning to avoid or minimize your potential AMT liability? It's based largely on conjecture, as Congress has adjusted the AMT calculation on an annual basis for several years running. And guess what? The 2007 adjustments have not been enacted yet. The House and Senate have very different ideas about what changes should be made this year. Maybe they'll get it done by the end of the year, leaving you little or no time to plan to reduce your 2007 tax liability.
Congress feels it must adjust the AMT calculation this year for a very simple reason: The AMT is being avoided by the wealthy and, instead, is ensnaring taxpayers it never intended to target-the middle class. Many wealthy taxpayers have the wherewithal to procure effective tax planning and to structure their affairs to avoid the AMT. But there are additional reasons why this tax is missing its target.
First, the "tax preferences" and other adjustment items used to calculate the AMT don't effectively target the tax minimization schemes or tax attributes of the tax-avoiding wealthy. On average, the two biggest AMT-producing adjustments are for state and local tax deductions and personal exemptions for oneself, spouse, and dependents-things a lot of ordinary people have.
Second, the tax code fails to include an inflation adjustment for the AMT exemption. The original exemption amount was adequate in holding the AMT at bay for the middle class. With time, the value of the exemption has gradually eroded, exposing more taxpayers to AMT.
Finally, the Bush tax cuts-especially the 2001 and 2003 legislation-reduced individuals' regular income tax liability, in many cases lower than the AMT, thus triggering it. The administration most likely knew this would happen but was unable to fix the problem without substantially raising the "cost" of the cuts and jeopardizing their passage.
The AMT, if not modified, is projected to be levied on 23 million taxpayers in 2007, rising to 31 million in 2010 and 36 million in 2017. This would be very disruptive, if not chaotic, to the taxpaying public, exacting a heavy toll in time and in additional tax liability. So, what to do?
Since 2001, the legislative and administrative branches have taken the modest step of slowing the reach of the AMT by annually raising the exemption. While this plugs the dike for the time being, new annual plugs are getting more and more costly. Many, therefore, advocate a longer-term or permanent solution, but how we get there is a point of great contention.
The 10-year cost to outright repeal the AMT is projected to be in the neighborhood of $800 billion if the Bush tax cuts are not extended-ballooning to $1.3 trillion if they are.
With the PAYGO (pay as you go) rules revived in the 110th Congress, cuts to or repeal of the AMT must be paid for with some combination of tax increases and spending cuts. The recent inability of Congress and the administration to enact meaningful spending cuts means that painful tax increases will likely be the result of an AMT fix.
Some members of Congress argue that AMT reform shouldn't be offset by tax increases or spending cuts because Congress never counted on AMT being the revenue raiser it is today. They contend that leaving out an inflation adjustment was an oversight by Congress. If that argument is accepted, we tack on another trillion dollars in debt, give or take a few hundred billion, and gut the PAYGO rules. This probably won't fly.
Some folks support reworking the AMT to lift the burden off the middle class and put it on the wealthy. Others see the AMT "crisis" as an opportunity to segue into comprehensive fundamental tax reform- not a bad idea, perhaps. The Internal Revenue Code really does need a long-overdue tune-up.
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www.probeauty.org/advocacy
posted: sam leyvas
professional beauty association
Originally published July 2007. Reprinted by permission, uschamber.com, August 2007. Copyright 2007 U.S. Chamber of Commerce - All Rights Reserved.
