Alternative Minimum Tax
From Wikicpa
The Alternative Minimum Tax (AMT) system is part of the federal taxation 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, Pub. L. No. 91-172, 83 Stat. 487 (Dec. 30, 1969), and became operative in 1970. It targeted 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, Pub. L. No. 95-600, 92 Stat. 2763 (Nov. 6, 1978), significant provisions of which (with respect to the AMT for individuals) are codified at Internal Revenue Code sections 55(a) and 55(b)(1), effective for tax years that began after December 31, 1978.
The AMT affects taxpayers who have what are known as "tax preference items." These include 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. Certain tax credits can also trigger the AMT.
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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.
Criticisms of the tax
Critics of the AMT argue that it suffers from various flaws:
- The AMT is an extremely complicated system of rules, leading to high compliance costs.
- The AMT does not correct for inflation, leading to unplanned effects as time goes by. Starting around 2004, the AMT began affecting middle-class incomes, at least by the standards of areas with high cost of living.
- The AMT disproportionately affects citizens of states with high taxation, since local and state taxes are considered deductibles under current federal tax law but not under the AMT. Because many of these states have voted Democratic in recent United States Presidential elections (for example New York, California, New Jersey) and many of these states also have high per capita incomes but also high cost of living, AMT is sometimes referred to as the "Blue State Tax".
- AMT is not a tax on profits, but a tax on "fake profits". For example, if you have a carryforward loss from stock trades, you cannot use them for AMT. Regular tax calculation allow you to carry forward losses.
- AMT causes market distortion in capital markets. For example, you would pay less taxes to hold on to 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 free markets.
- AMT reduces investment in companies (and reduces job creation by making capital harder to attract) by increasing the capital gains tax.
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.
Complexity and Unintended Consequences
The AMT itself has a simpler system of rules compared to the regular income tax rules; indeed, it is similar to a flat tax and contains fewer loopholes. The complication arises because individuals must compute their tax levels twice, under two different systems, and pay the greater amount. This can become quite a shock if the taxpayer undertook certain actions or investments because of their tax advantages, since those deductions often do not apply under the AMT, or a great waste of time if the amount owed under the AMT would be smaller. In addition, residents of states with low taxation frequently complain that the regular tax system which allows deduction of local and state taxes is unfair, since residents of states with high taxation receive the benefits from the spending which results from their high local and state taxes. Since the states with high taxation are, on average, wealthier per capita, this allows the wealthier states to raise taxes in order to keep more of their money in-state and reduce the amount redistributed to poorer states.
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.
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". Republicans, representing fewer constituents (middle class and in general) affected by the AMT, wish to package AMT reform together with extensions of other tax cuts which Democrats in general oppose. In addition, some Republicans, favoring a flat tax, may see the extension of the AMT to most taxpayers as an easy way of achieving that goal.
