25 March 2008

The Alternative Minimum Tax

Alternative Minimum Tax was due on 3.01% of tax returns in 2005. But this varied widely by state. The states with the highest rates were:

New Jersey 6.82%
New York 6.00%
Conecticut 5.9%
District of Columbia 5.19%
Maryland 5.02%
California 4.86%
Massachusetts 4.74%

The overwhelming factor that influences AMT impact rates is the level of deductible state and local taxes that a state imposes. Ordinary income taxes allow taxpayers a state and local tax deduction under Section 164 of the Internal Revenue Code, but AMT found at Sections 55-58 of the Internal Revenue Code does not. The state and local tax deduction reduces federal revenues by about $75 billion a year.

AMT disproportionately impacts states with Democrats in Congress.

A March 2008 article by Brian D. Galle in the Michigan Law Review examines the impact of the partial repeal of the state and local tax deduction via the AMT from a theoretical tax justice and federalism perspective.

In a nutshell, from a 2002 report, AMT works as follows:

Taxpayers subject to the AMT must calculate their tax liability twice: once under regular income tax rules and again under AMT rules. If liability under the AMT proves higher, taxpayers pay the difference as a surcharge to the regular tax. Technically, the difference paid is their AMT.

To calculate their AMT, taxpayers add to their regular taxable income two categories of items called AMT preferences. Exemption preferences, which can be deducted from income under the regular income tax, are disallowed in the AMT. These items include personal exemptions, the standard deduction, and itemized deductions for state taxes and miscellaneous expenses. Middle-income AMT taxpayers are the most likely to be hit by exemption preferences.

Deferral preferences allow taxpayers to postpone regular income tax payments by hastening deductions or delaying income recognition. The AMT rules limit the extent to which taxpayers can use deferrals by, for example, allowing less generous depreciation deductions. Compared with exemption preferences, deferral preferences are more complex, tend to affect high-income filers, and generate less AMT revenue.

Once taxpayers add in all applicable preferences and tally income, they subtract the AMT exemption . . . The resulting income level is taxed at flatter rates than under the regular income tax. The statutory AMT tax rate of 26 percent applies to the first $175,000 of net income above the exemption. For income over that level, a 28 percent tax rate applies. . . . Many taxpayers' effective AMT rate, however, is significantly higher, because the exemption phases out at a 25 percent rate over higher income ranges. The AMT parameters are not indexed for inflation.1


The AMT exemption was set at $66,250 for joint filers and $44,350 for single filers in 2007 as a result of the Tax Increase Prevention Act of 2007. Those numbers will drop in 2008 without Congressional action.

Notably, the exemption for municipal bond income (other than certain private activity bonds), which is a key factor that allows high income taxpayers to pay no income tax (the reason it was adopted in the first place), is not affected by the AMT, nor is the capital gains tax preference with also overwhelmingly aids high income tax payers. As a result, the upper middle class, rather than the rich, bear most AMT burdens.

AMT liability has increased about 50% due to lower ordinary income taxes that are reclaimed under the AMT, and about 50% due to a lack of indexing for the AMT exemption.

An AMT repeal would cost about $60 billion a year in tax revenues. Allowing dependent exemptions under the AMT would cost about $17.5 billion a year in tax revenues. Allowing state and local tax deductions for AMT purposes would cost about $36 billion a year in tax revenues. But allowing both dependent exemptions and state and local tax deductions would cost about $44 billion a year, rather than $53.5 billion a year, because their impact overlaps.

According to a 2004 estimate that assumed that there would be no AMT relief:

Until 2000, less than 1 percent of taxpayers paid the AMT in any year. Under current law, however, the number of taxpayers affected by the AMT will grow from just over 1 million in 2001 to nearly 30 million in 2010 before falling back to about 23 million in 2014 after the expiration of the 2001 and 2003 tax cuts (see Figure 1). Twenty percent of all taxpayers--and 40 percent of married couples--will owe AMT in 2010. AMT receipts in 2010 will total about $90 billion, roughly 7 percent of total individual income tax revenue. Nevertheless, the AMT is only partially successful in imposing tax liabilities on all high-income people: in 2001, nearly 1,100 tax filers with AGI above $500,000 paid federal income taxes only because of the AMT,(9) but almost 900 people in that income range paid no federal income tax at all despite the AMT.(10)


Current estimates are that about 20 million people would owe AMT but for the law passed in 2007.

I would favor adding preferrential capital gains and qualified dividend rates as AMT preferences, including all municipal bond income in alternative minimum taxable income, disallowing interest on a second or vacation home, and allowing the standard deduction (if elected), personal exemptions and the state and local income tax deduction against alternative minimum taxable income.

This would shift the AMT burden to the intended targets, i.e. high income people who pay unfairly low taxes under the current system, while providing relief to middle and upper middle class families who aren't receiving any unusual or exceptional benefits under the current system.

1 comment:

Michigan Law Review said...

Hello,

Could you please update the link to the Galle article? An official version is available on the Michigan Law Review website:
http://www.michiganlawreview.org/archive/106/5/galle.pdf

Thanks.