The Alternative Minimum Tax

What would you think about having to calculate your federal income taxes twice each year? That may be in the cards for American taxpayers, more than 20 million of them, in 2011 if Congress chooses not to fix the alternative minimum tax, or AMT, before the year end.

The AMT was enacted in 1969 with the intention of ensuring that high-income taxpayers weren't able to avoid paying taxes. The idea was that wealthy taxpayers should not be able to eliminate taxable income by taking advantage of the many tax breaks that were intended for the middle class, like the home mortgage interest deduction or real estate tax deductions. With the AMT, taxpayers calculate their federal income tax twice, once under the usual rules that we all deal with, including all available deductions, and then they do it again under the AMT rules, which eliminate most of those tax breaks. The taxpayer then pays the higher of the two amounts.

Over the years, however, the AMT hasn't been kept up-to-date and isn't working like they originally intended. For one thing, AMT isn't indexed for inflation. So even though inflation has made our gross income go up, our buying power hasn't. This means that the number of taxpayers now subject to the tax includes people who were never intended to be included. According to the National Taxpayer Advocate, 77% of the income subject to AMT is actually attributable to the disallowance of ordinary deductions, like those for state and local taxes as well as personal and dependency deductions rather than from actual increases in income. This is in fact the opposite of what the AMT was supposed to do!

You'd think the solution would be easy. Just eliminate the AMT. Why don't they take this easy route out? Well, it's all about the money. The AMT brings in about $70 billion per year. The way the economy has been the last few years, that's more money than anyone can afford to eliminate from the federal budget. Nobody in Congress, Democrat, Republican or other, wants that have to take the heat for that. And industry experts don't really push for it because the AMT is a huge money maker for CPA's. Taxes are complicated, and the AMT is horrible. Your tax preparer knows he can charge a pretty penny for taking this one off your hands.

So far in 2010 it looks like Congress is doing what it does at the end of every year: scrambling to "patch" the AMT, rather than just eliminating it. Congress generally raises the limit for income subject to AMT at the end of each year, but this year they may try something a little different. A bipartisan group, including Sen. Max Baucus (D-Mont.) and Sen. Chuck Grassley (R-Iowa), sent a letter to IRS Commissioner Doug Shulman proposing another one-time fix. They told the Commissioner: "We will work to craft the AMT provision so that, in the aggregate, not one additional taxpayer faces higher taxes in 2010 due to the onerous AMT ... We urge the Internal Revenue Service to take all steps necessary to plan for changes that would be made by the legislation."

Without any changes, middle class taxpayers could end up with additional taxes attributable to AMT averaging about $3,800. In fact, for 2010, the exemption has actually decreased under current legislation to a mere $33,750 ($45,000 if married filing jointly or qualifying widow or widower; $22,500 if married filing separately). As of now, the IRS was still expecting that to change, noting on its website, "Congress is expected to consider legislation that would increase the AMT exemption amounts" and promising to post updates as soon as possible. With just a few weeks left in 2010, we will be paying attention.