Alternative Minimum Tax * AMT * Repeal AMT * Reform AMT * Standard Deductions * Inflation Adjustments

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History of the Alternative Minimum Tax

An Alternative Minimum Tax (AMT) is part of our current tax code. It's a tax applicable to individuals, corporations, estates, and trusts. It was originally passed into law to "catch" wealthy individuals who were trying to avoid paying taxes through loopholes.

The AMT was enacted by the Tax Reform Act of 1969, taking effect in 1970. Treasury Secretary Joseph Barr prompted the enactment action with an announcement that 155 high-income households had not paid a dime of federal income taxes.The households had taken advantage of so many tax benefits and deductions that reduced their tax liabilities to zero. Congress responded by creating an add-on tax on high-income households, equal to 10% of the sum of tax preferences in excess of $30,000 plus the taxpayer's regular tax liability.

The tax went under several changes through the years, and it current form was currently passed under Tax Equity and Fiscal Responsibility Act of 1982. The law changed the AMT from an add-on tax to its current form: a parallel tax system.

The problem with the alternative tax law from 1982 is that Congress is never adjusts for inflation automatically. Over time, US household income has increased. However, the income level at which the additional tax is imposed was never increased to keep up. This means that people making an income once considered to be wealthy are now forced to pay a prohibitively high tax meant to tax the well-to-do. The lack of an automatic clause means that Congress has to pass a "patch" every few years to prevent individuals from paying extraordinary high taxes.

Calculating AMT

To understand the AMT, let's review a simplistic view of how your taxes are calculated.

• You start with adding up the income on your W-2's and/or 1099's.
• You take whatever deductions you can to minimize your income, for example, the mortgage interest deduction. The smaller your income after deductions, the smaller your taxes.
• Calculate your taxes based on the "deducted" income.
• You calculate at this point what your alternative minimum taxes are.
• You use the larger of the AMT or taxes calculated with "regular deductions.
• At larger incomes, there are fewer deductions to lower the taxable income.

Exemptions and Deductions

Under the AMT, taxpayers are allowed a flat exemption amount but not personal exemptions or the standard deduction. Allowable deductions for the individual under AMT:

• Miscellaneous itemized deductions are not allowed. These include all items subject to the 2% "floor", such as employee business expenses, tax preparation fees, etc.
• The deduction for charitable contributions of property is limited to the basis of the property.
• The home mortgage interest deduction is limited to interest on purchase money mortgages for a first and second residence.
• Medical expenses may be deducted only if they exceed 10% of Adjusted Gross Income, as compared to 7.5% for regular tax.

The full table:

Controversy Surrounding AMT

There are a two schools of thought on the AMT. The first one is the AMT should be repealed. The second one is that it should be amended to have automatic inflation adjustment mechanism or other provisions so that middle income American are not overly taxed.

Repeal

Some groups advocate repealing the AMT rather than attempting to reform it. One such group, the Cato Institute, notes that:

• Many tax loopholes the AMT was designed to address have since been closed;
• The AMT is needlessly complex and burdensome to taxpayers;
• A full repeal would leave Federal revenues as a fraction of GDP at about 18%, its average value in recent decades.

Reform

The loss incurred by totally repealing the tax is expected to be between $800 billion and $1.5 trillion in federal revenues over 10 years, according to Aviva Aron-Dine (2007-02-14). "Myths and Realities about the Alternative Minimum Tax". Center on Budgetary and Policy Priorities. (see myth 3)