More of Middle Class Now Subject to AMT

Thanks to a last-minute fix by Congress, most taxpayers who take advantage of the tax credits enacted in 1997 and effective in 1998 won’t find their benefits snatched away by the alternative minimum tax.

But the fix doesn’t go far enough: It (a) doesn’t cover quite everybody; (b) is good for only a year; and (c) doesn’t get at a more fundamental problem, which is that the AMT is starting to bite on middle-class taxpayers it was not meant for.

In fact, the AMT is another example--and they are legion--of how in Washington yesterday’s solutions are today’s problems.

The alternative minimum tax, enacted in 1986, was designed to prevent high-rollers from using deductions, credits and other benefits to get away with paying little or no income tax. In simple terms, the AMT requires taxpayers with lots of deductions and credits to compute their regular tax, then go back and do it over, putting most of the “preference items,” as the benefits are called, back into their income.

This gives a new figure for income. The taxpayer then gets to subtract a standard exemption--$45,000 for married couples, $33,750 for singles--and then must apply a special AMT tax rate of 26% (or 28% for AMT income over $175,000) to determine a new tax figure. If that new figure is higher than the regular tax, that is what is owed.

Back in 1986, the exemption was large enough to eliminate the AMT for all but a small number of individuals--114,000 out of roughly 100 million, according to a study done by Rep. Bill Archer (R-Texas), chairman of the Joint Committee on Taxation for House Ways and Means Committee.

But neither the AMT exemption nor its tax brackets were indexed, so they remain at their 1986 levels.

Because of inflation and ordinary economic growth, however, taxpayers’ incomes have been rising steadily. So have some of the major tax benefits that must be included in income for AMT calculations. Among these are state and local taxes, which rise with income, and personal exemptions, which are indexed. Most people don’t think of the state and local tax deduction or the personal exemption as an abuse, but the AMT treats these as such.

And they are a big factor in AMT calculations. According to Treasury Department figures, in recent years state and local taxes alone have accounted for nearly half the amount taxpayers must restore to their income as AMT preferences, whereas personal exemptions have made up about 13%.

Thus the AMT has emerged as a sparkling example of what is wrong with the nation’s tax laws and why it is so difficult to fix them:

* The AMT was enacted with an arguably laudable purpose: to prevent excessive use of legal tax-cutting provisions. But the AMT is very complicated.

Since it is often difficult, if not impossible, for taxpayers to figure out by eyeballing the numbers whether they will have to pay the AMT, there is no choice for many but to do the whole calculation. The addition of the new tax credits compelled the IRS to whip up a work sheet specially for them. * It interacts in unexpected ways with other tax provisions. There is some suspicion that lawmakers do understand this interaction and like it because it reduces the cost of some ostensible tax cuts. There’s no doubt that the AMT can easily sandbag the ordinary taxpayer.

For example, the new tax credits originally would have been allowed against ordinary taxes only to the extent those taxes exceeded the AMT. Thus some taxpayers expecting tax reductions of several thousand dollars would in fact have realized less, because their credits would have reduced their regular tax below the AMT. This problem has been fixed at least for 1998 and for most people.

* It hits unintended targets. By including state and local taxes, personal exemptions and other benefits normally available to everyone, and by leaving the thresholds at 1986 levels, the AMT is slowly roping in the middle class. Before the 1997 tax cuts and the 1998 fixes, the number of taxpayers hit by the AMT had been expected to grow from about 900,000 today to 8.5 million in 2008. The 1997 cuts will expand the AMT’s reach by 3.2 million more taxpayers in 2008 unless the 1998 fix is extended.

There is probably a large number of taxpayers who should pay the AMT but do not because they do not realize they have to, Steuerle added.

* Finally, it’s difficult to fix.

“The AMT is a classic case in which Congress and the executive branch believe that the law doesn’t make much sense, but they have been unable to act because of multiple constraints,” Steuerle said.

The key hitch is revenue. The AMT is expected to raise $4.3 billion this year, according to the joint tax committee. In later years it will raise even more, though just how much depends on whether this year’s fixes are extended and in what form. Absent those fixes, the AMT could be raising as much as $20 billion a year by 2008, by some estimates.

Under congressional budget rules, tax changes that cost the Treasury money have to be “paid for” by offsetting changes that raise revenue.

“I think there’s a general agreement that [the AMT] ought to be indexed, but they ought to pay for it in a responsible and equitable way--and responsibility and equity are not the hallmarks of the current Congress,” said Robert S. McIntyre of Citizens for Tax Justice, which has long campaigned against tax breaks for rich individuals and corporations.