When the subject of the once obscure alternative minimum tax comes up, millions of people are finding there's no alternative to what has become an increasingly common unpleasant experience.
About 3 million Americans are now subject to the alternative minimum tax, but that number could increase to 15 million, largely because of President Bush's package of tax cuts. That's right, tax cuts.
While middle-class taxpayers would face higher bills and increased aggravation, Congress now faces a problem that looks increasingly costly, both economically and politically. Repealing the AMT could cost the government $700 billion over the next 10 years, but doing nothing could strip away the benefits of recent tax cuts, boosting voters' bills and sending them to the polls in an angry mood.
The alternative minimum tax is a simple idea surrounded by a slew of complications. It uses a different formula to calculate your tax bill, and it is imposed if your regular tax bill would be lower than the tally under AMT. (For those who are liable to get caught in its net, you actually have to calculate your taxes twice.) It's a strange transformation for a measure passed 35 years ago to keep a handful of very rich people (with incomes over $200,000) from dodging tax payments by stripping out a slew of tax exemptions.
Regular taxes have a range of income brackets, from 10% to 35%, and figuring out tax liability generally involves compiling a list of allowable exemptions and deductions, such as interest on a mortgage, child tax credits, the interest on home equity loans and the cost of state and local taxes.
The AMT has a basic exemption and fewer allowable deductions, working almost like a flat tax at rates of 26% and 28%, and it is not indexed for inflation, explains Michael Kitces, a financial planner in Columbia, Md. But that is largely unknown to most taxpayers until it hits them for the first time, and by then it is often a costly lesson.
The AMT now ensnares about 3 million people, many of whom have several children or live in states with high taxes.
"We've finally gotten to the point where lots and lots of people earning $100,000 to $200,000 a year have hit the point that their regular tax bills have dropped below what their fixed AMT bill would be," he says. "Since you have to pay the greater of the two, suddenly you have to pay the AMT for the first time."
According to the Urban-Brookings Tax Policy Center, 33 million households could be subject to the AMT by 2010, when the last of the Bush tax-cut provisions expire. As many as 92% of all households earning between $100,000 and $500,000 a year would use the AMT, while 73% of those earning between $75,000 and $100,000 would use the system. As many as 37% of households earning more than $35,000 a year would have to use AMT.
"Nowadays, it's become a monster," says Tom Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants. "With every year it's affecting more and more people, and that makes it more and more imperative that it's repealed. It's bad tax policy."
Because it's not indexed for inflation -- while regular tax brackets are -- the AMT threshold doesn't move up with peoples' incomes, except for the temporary measure passed in 2003 to widen the effectiveness of the Bush marginal-rate tax cuts. The exemption for a married couple was raised to $58,000 for both 2003 and 2004. The House of Representatives last week approved legislation raising it again to $58,950, as a one-year temporary fix, applicable for 2005. Previously, the exemption was $45,000.
The Senate is likely to delay passing its own version of AMT relief as long as possible because of the upcoming national political conventions and the presidential election. But it might have to vote in October, if only to accommodate the Treasury Department's printing schedule for next year's tax forms, says Clint Stretch, executive director of tax policy services at Deloitte & Touche in Washington.
He says residents of states with high taxes, such as California, New York and Wisconsin, are finding unlikely connections with people in states with high real estate taxes, such as Texas.
And as more people are affected, the unhappier they'll be about the AMT pickle, Kitces says. Click here to find out
how the AMT may affect your investments.
"To some extent, the politicians knew this was coming, but if they'd just passed the tax cut without the increased AMT exemption, that would have automatically thrust 5 million to 10 million people into AMT, and that would have been politically unpopular," Kitces says.
Fixing the problem won't get a lot of enthusiastic support from politicians either, says Len Burman, a senior fellow at the Urban-Brookings Tax Policy Center, which supports the repeal of the AMT.
"It's not rocket science, but politically it's difficult," he says. "Congressmen like these hidden taxes, and they all know it's going to cost a lot to fix it."
Stretch said the one-year increased exemption recently passed by the House will cost the Treasury about $17 billion alone. Multiply that revenue loss or even a greater one where the AMT threshold was raised to a more generous level, and it's easy to see how the federal budget deficit would bulge. That makes one aspect of tax relief a complicating factor in budget politics.
"At some point, people are going to have to come to terms with the fact that you have to pay your bills," he says. "My perspective is that you have to deal with it soon rather than later, but I probably couldn't be elected dogcatcher."