Alternative tax a growing problem for middle class taxpayers
Wednesday, February 6, 2008
By Ilene Davis
First built into the tax system in 1969, the alternative minimum tax, or AMT, was designed to ensure a small number of high-income individuals could not avoid paying federal income taxes.
In the ensuing decades, however, the income level that triggers the AMT hasn't been adjusted for inflation, and the number of people being forced into using the alternative tax has crept upward. According to an article published by OMB Watch, in 1995 a total of 414,000 individuals paid the AMT, growing to 1.3 million in 2001.
Federal tax changes enacted at the urging of President George W. Bush dramatically increased the number of taxpayers incurring liability under the AMT, according to a paper published by the Urban Institute. The reason, the economists writing for the Urban Institute reported, is that the lowered tax rates and increased deductions approved in the 2001 and 2002 tax cuts were not also applied to the AMT.
Four million taxpayers paid their taxes based on AMT calculations last year, and before Congress enacted a one-year fix in late December, a projected 25 million taxpayers were going to have AMT liability for 2007.
In our area, accountants said they are also seeing the trend of increasing numbers of people paying the AMT over the past several years.
Jim Hillin, CPA at Hillin & Clark, PC., says over the past 10 years he has noticed a "significant additional number of individuals" who have been affected by the tax.
Debbie Beussink-Eudy CPA, of Beussink, Hey & Roe agrees, and says that even five years ago there wasn't the worry of the AMT tax that there is now.
"We'd do 2,500 tax returns and maybe had 25 with AMT liability," she says. Now potentially 25 percent of their middle income taxpayers will owe the tax.
She says that because of the way the AMT is set up, it has graduated to where many middle income people have to worry about paying the tax.
"It's just not a thing for high income people, which was what it was intended to do," she says. "The middle income have become the high income people."
Calculating the AMT follows a different set of rules than calculating regular income tax. Most tax benefits available under regular tax are reduced or eliminated entirely and AMT calculations do not allow particular exemptions and deductions.
Under the standard tax code, income is taxed at rates that grow from 10 percent for the lowest taxable incomes to a marginal rate of 35 percent for those with the highest incomes. Once a tax liability is calculated with all the allowable deductions, the result is compared with the potential liability under the AMT rules.
If the AMT amount is higher than the regular tax calculation, the difference between the two is owed in addition to the regular tax.
"The flat rate of 26 percent in the alternative minimum tax calculations catches some additional taxpayers," Hillin says.
One income source that can trigger the AMT is a large capital gain, such as the sale of stock or a small business. The maximum tax rate on capital gains in the standard income tax is typically 15 percent, much lower than the AMT. Sometimes it doesn't take a very large gain for the AMT to take over, says Hillin.
"There are some deductions that are allowed for regular income tax that are not allowed for AMT, so that traps some individuals into being subjected to the AMT," he says.
Beussink-Eudy explains any deductions for income, state, real estate and personal property taxes, as well as miscellaneous deductions are added back when calculating the AMT.
She and Hillin use the same example of a traveling salesperson who claims personal business expenses.
"That falls in the miscellaneous deduction category which is not deductible by AMT," says Hillin.
According to Hillin there are a couple categories of people who could be more subject to AMT liability, including individuals, single or married, with relatively high income and who have a fairly substantial gain in a particular year. Though he says "people are really quite limited on what they can do to avoid it. It's one of those things that's somewhat unavoidable and sometimes surprises people at the end of the year," he says.
A final bill providing one year of 2007 tax relief for 21 million taxpayers passed just a few days before the holiday recess. The "patch" was approved after several months of debate, but the AMT will still be an issue of discussion next year, because the changes made in December are for the 2007 tax year only.
"The problem Congress must deal with is either repeal this or fix it so that it does not apply to nearly the number of taxpayers it does now," says Hillin.
The change enacted in December resulted in a $50 billion loss of revenue for Uncle Sam. The bill was delayed over Democratic and Republican arguments over whether to raise other taxes to offset the loss.
"It's a loss of revenue to the federal government and we already have a budget deficit. They'd like to raise other taxes to offset" the AMT, "but the difficulty is deciding what other taxes to raise to do so," he explains. "That is what delayed the current patch for awhile."
Hillin also says it is going to delay the process of returns for the IRS. They are going to have to repair their software which might lead to a 10 week delay in processing returns.