The Alternative Minimum Tax, designed to ensure that millionaires didn’t escape paying taxes through clever use of loopholes, is hitting an increasing number of middle class taxpayers:
The alternative minimum tax is becoming even stickier — and could entangle even more taxpayers next year. Congress is expected to recess for the holidays without an agreement on how to limit the effect of the AMT for 2006. While the AMT is expected to affect about 4 million taxpayers for 2005, that number will swell to about 21.6 million for 2006 unless Congress acts to lessen the impact. Congress has said it will do so next year, making it retroactive to Jan. 1, but it’s still unclear exactly how that will play out, since other initiatives, like extending cuts on capital gains and dividends, loom in the background.
“Congress can address that dilemma, or growing probability of AMT exposure, by passing legislation that retroactively reduces that bite, and it would probably be as simple as maintaining or increasing the exemption amount,” says John Nersesian, wealth-management strategist at Nuveen Investments. “The exemption is used to ensure that moderate-income taxpayers do not fall victim to the tax.”
In the current tax year, married couples filing jointly with income above $58,000 may be subject to AMT, though that figure, or exemption, is dropping to $45,000 next year unless new legislation is passed. The exemption is phased out for those with higher incomes, or $150,000 for married couples filing jointly.
The AMT was never intended for the masses: It’s a parallel tax system that was installed in the late 1960s to ensure the wealthiest Americans were paying their fair share of taxes by reducing the amount of deductions they can take. However, it was never indexed for inflation and has increasingly trapped more middle-class taxpayers. Indeed, both proposals to revamp the tax code announced last month by the Federal Tax Reform advisery panel recommended eliminating the AMT.
To determine AMT tax liability, two calculations are necessary: one under the traditional tax system and another under the AMT system, where various deductions — such as state and local income taxes, property taxes, miscellaneous deductions and personal exemptions and others — are added back. You must pay the greater of the two.
Though the AMT rate is either 26 percent or 28 percent — a lower rate than the highest marginal tax bracket of 35 percent — it’s applied to a wider base of income, making that tax bill more costly. Also, unlike the traditional tax code, the AMT isn’t a progressive tax, but rather a flat tax.
The whole notion is quite bizarre. The tax code is set up with deductions and exemptions to both incentivize certain behaviors and to account for the fact that not all “income” is really that. A person makes investments, charitable contributions, and other financial decision based on the rules of the game. To have the rules effectively changed on them after the fact is outrageous.
Related:
