In 1969 the Secretary of the Treasury testified before Congress that 155 individuals with Adjusted Gross Income of more than $200,000 (over $1 million in today’s dollars) paid “0” tax on their 1967 tax returns. Congress received more letters that year on the Secretary’s testimony than its did on the Vietnam War. Of course Congress being Congress, rather than acting logically and eliminating the loopholes in the tax code that allowed the high income individuals to avoid paying tax, it created a complicated alternative tax system, originally known as the Minimum Tax, which has since evolved into the Alternative Minimum Tax (AMT).
The passive activity and other rules included in the Tax Reform Act of 1986 effectively closed many of the loopholes used by the wealthy to avoid taxes that had led to the creation of the AMT. Unfortunately the Act did not do away with the AMT. Instead, it increased the reach of this alternative tax system as a “back-door” method of offsetting some of the front-door tax reductions.
None of my clients ever paid AMT until the early 1990s. Now several clients are regular victims of AMT, and I must check each year to see if the AMT applies for many other clients.
A favorite instructor for the National Society of Tax Professionals, who has since gone on to his final audit, used to tell the tale of one of his older clients. One tax season, after signing his finished returns, the gentleman told the instructor, “Dennis, I will continue to come to you to have my taxes prepared each year, because you always make sure I pay the ‘minimum tax.’ I like that! My old preparer never did that for me. In fact, one year he actually had me pay the ‘maximum tax!'”
FYI – when I began preparing 1040s in 1972, there was also a “maximum” tax – which made sure that earned income was not taxed at more than 50%.
Like many taxpayers today, Dennis’s client was confused about the concept of the “minimum tax.”
The AMT is a separate tax system which does not allow you to deduct personal exemptions, the standard deduction, state and local income, sales, real estate and personal property taxes, home equity interest or “miscellaneous” items such as employee business expenses, investment expenses and tax preparation costs. In addition, certain “tax preference items” must be added back to income in calculating the tax. The net Alternative Minimum Taxable Income, after deducting an exemption amount based on filing status and level of income, is taxed at a flat rate of either 26% or 28%. A taxpayer calculates his tax liability under both the “regular” income tax rules and the AMT rules and must pay the higher amount.
“Alternative Minimum Tax” is a misnomer. It is neither an alternative option nor is is a minimum tax. The AMT is MMT – “Mandatory Maximum Tax”.
The AMT targets not the very wealthy, but middle and upper middle class taxpayers in highly taxed states. Those in the top brackets – the top 1% of taxpayers - are rarely subject to AMT, because the “regular” tax rates of 35% and 39.6% greatly exceed the top AMT rate of 28%.
What would make someone a victim of the Alternative Minimum Tax?