The AMT Effect for Individuals

Alternative Minimum Tax (AMT).

It is one of those things you hope you have to deal with someday, because that means you are a high-income earner. But when you do, it makes you cringe. The AMT represents a flat tax computation that you must pay if it is greater than your regular tax. AMT is calculated for everyone, even if you don’t see it in the background of your tax return.

So why discuss the AMT in mid-December while everyone is thinking about tax extensions and holidays? As part of the current tax extension agreement yet to be passed; the AMT patch is a big, quiet part of it. For years, tax practitioners have been clamoring for a permanent fix to the AMT system. Ask a tax preparer about the late extension passed in 2007. If Congress does not pass the extension this year, it is estimated that 28 million taxpayers will pay AMT, with 82% of those taxpayers earning below $200,000. You will notice below that in 2009, 4.5 million were subject to the AMT.

Guess what? I decided to enter my current tax numbers into my 2010 tax software last night, so I could see where I stood for 2010 on the current laws. Without having the AMT patch built into the software, I got to see what a difference it makes and it isn’t pretty. My chest actually tightened up; really.

More on AMT -

The AMT can be traced back to the Tax Reform Act of 1969. While it has seen many changes over its 40 years, in 1986 the AMT was originally a response to high-income tax payers escaping income taxation through deductions and tax benefits, the AMT system originally was an add-on tax system. Today it runs parallel with the standard tax system.

The AMT was enacted to target a few hundred high-income households. In 2009, an estimated 4.5 million people were affected by the AMT. Whoops! Sounds like the AMT is not used for the same purpose it used to be. Especially if the above is true and a patch is somehow not passed. That would leave 28 million people paying the tax originally targeted to a few hundred households.

AMT has not been indexed for inflation, which has left many “upper-level” income earners subject to the tax who may not have been subject to the tax 40 years ago. The AMT exemption has been increased, but this is really the only form of inflation adjustment AMT has seen. Interestingly, the exemption amount isn’t the only item that has been increased—so have the respective AMT tax rates, now sitting at 26/28%. Yikes!

So what makes AMT different from the standard tax computation? Certain items in the standard tax are added back in for AMT computations, like other taxes paid and miscellaneous itemized deductions. The deduction for personal exemptions is not allowed, instead granting an exemption that is phased out at higher income levels.

Many feel this is a fundamental flaw with new legislation and new taxes. They start with a purpose, but naturally the revenue ends up being relied on for other purposes, and then we forget how to function as an economic nation without it. This argument has been made with the 3.8% Medicare surtax, because it is not indexed for inflation. We are told it is for the “rich” only now, but what will it be in 20 years?

Lawmakers continue to speak of a 1986 like tax overhaul next year. Hopefully this tax overhaul will include a permanent fix to the Alternative Minimum Tax. Or maybe, just maybe, it will be removed.

Don’t hold your breath.