Alternative Minimum Tax - Opinions About AMT

Opinions About AMT

In recent years, the AMT has been under increased attention.

The AMT rate has not been changed at the same times as regular income tax rates. The tax cut passed in 2001 lowered regular tax rates, but did not lower AMT rates. As a result, certain people are affected by the AMT who were not the intended targets of the laws. People with large deductions, particularly those resident in states or cities with high income tax rates, or those with nonqualifying mortgage interest deductions, are most affected. The AMT also has the potential to tax families with large numbers of dependents (usually children), although in recent years, Congress has acted to keep deductions for dependents, especially children, from triggering the AMT.

Because the AMT is not indexed to inflation and because of recent tax cuts, an increasing number of middle-income taxpayers have been finding themselves subject to this tax. The lack of indexing produces bracket creep. The recent tax cuts in the regular tax have the effect of causing many taxpayers to pay some AMT, reducing or eliminating the benefit from the reduction in regular rates. (In all such cases, however, the overall tax payable will not increase.)

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 to most taxpayers who owe AMT not realizing it until preparing their returns or being notified by the IRS. A brief issued by the Congressional Budget Office (CBO) (No. 4, April 15, 2004), concludes:

"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 state that it must use current law in its analysis, and at the time the above text was written, the AMT threshold was set to expire in 2006 and be reset to far lower values. Critics of the AMT argue that various features are flaws, though others defend some of these features:

• The AMT exemption and AMT exemption phase-out threshold are not indexed for inflation so that over time, the real values decline and the fraction of taxpayers subject to the AMT rises. This is known as fiscal drag or bracket creep.
• The AMT eliminates state and local tax deductions. (Arguments have been produced for and against deducting such taxes. For example, an argument against a deduction is that if taxes are viewed as a payment for government services, they should not be treated differently from other consumption.)
• The AMT disallows a portion of the foreign tax credit, creating some degree of double taxation for the more than 8 million American citizens living abroad. Some modest income families owe AMT solely because of currency fluctuations.
• Businesses and individuals have to do twice the amount of tax planning when considering whether to sell an asset or start a business. They must first consider whether a particular path of action will increase their regular income tax and then also must calculate if alternative tax will increase.
• Taxes are often owed in the year that an exercise of ISO stock options occurs, even if no stock is sold (which, for private or pre-IPO companies, may be because it is impossible to sell the stock). Although many taxpayers believe that in such a case no actual income exists, the bargain element of the exercise is considered income under the AMT system. In extreme cases, if the stock is private or the value drops, it may be impossible to realize the money the AMT demands.

"In 1986, when President Ronald Reagan and both parties on Capitol Hill agreed to a major change in the tax system, the law was subtly changed to aim at a wholly different set of deductions, the ones that everyone gets, like the personal exemption, state and local taxes, the standard deduction, certain expenses like union dues and even some medical costs for the seriously ill. At the same time it removed and revised some of the exotic investment deductions. A law for untaxed rich investors was refocused on families who own their homes in high tax states."

A further shift, involving many definitional changes and extensive reorganization, occurred with the Tax Reform Act of 1986.

A further criticism is that the AMT does not even affect its intended target. Congress introduced the AMT after it was discovered that 21 millionaires did not pay any US income tax in 1969 as a result of various deductions taken on their income tax return. Since the marginal rate of persons with one million dollars of income is 35% and the AMT uses a 26% or 28% rate on all income, it is unlikely that millionaires would get tripped by the AMT as their effective tax rates are already higher. Those that do pay by the AMT are typically people making approximately $200k–$500k.

Determining whether one is subject to the AMT can be difficult. According to the IRS's taxpayer advocate, determining whether someone owes the AMT can require reading 9 pages of instructions, and completing a 16-line worksheet and a 55-line form.