A: the Individual AMT: Problems and Potential Solutions

A: the Individual AMT: Problems and Potential Solutions

Thesis:

A: The Individual AMT: Problems and Potential Solutions

B: The Individual AMT: Why it Matters

C: Public Finance, Rosen

D: Alternative Minimum Tax 101

E: IRS

http://www.irs.gov/newsroom/article/0,,id=107843,00.html

Motivate

  • Certain types of income such as interest on state and local bonds are treated preferentially by the regular tax system.[c]
  • Allows for some high-income households to have little or no tax liability.
  • In 1969, Secretary of the Treasury announced that 155 individuals with incomes exceeding $200,000 had paid no federal income tax several years earlier.[c]
  • Creation of AMT
  • To ensure high income individuals having tax shelters paid at least some tax.
  • Congress believed these individuals were overusing certain tax deductions, exclusions, or credits and were not paying the full amount of taxes. [b]
  • Features
  • Broader tax base, lower tax rates, higher exemption, fewer allowable tax credits [b]
  • History
  • Started as minimum “add-on” tax on tax preferences that were excluded from the regular tax system (1970 to 1982), and the AMT beginning from 1979. [b]
  • Changes have been made in all major tax bills since 1969 to increase the number of high-income taxpayers who pay their fair share of the federal tax liability. [b]
  • Complicated tax system affecting relatively few taxpayers (700,000 in 1997) and raises relatively little revenue (4.5 billion in 1997).
  • By 2007, the number of taxpayers increases to 9 million, generating 21 billion of AMT tax liability. [b]
  • These extra taxpayers would come from the middle-class due to bracket creeping
  • Opposed to the initial aim of the AMT
  • These taxpayers would not be traditionally viewed as aggressive and abusive of the tax system [b]
  • Fundamental Problems
  • Regular income tax main parameters (e.g. personal exemption, rate brackets) are indexed for inflation whereas the that of AMT (AMT exemptions and others) are not

Synthesis

  • AMT is an auxiliary tax system with its own rules for tax base computation and own tax rate schedule.
  • Regular tax income + AMT preferences
  • AMT preferences include personal exemptions, standard deduction, itemized deductions for state taxes
  • The adjustments and tax preference items include such things as: standard or certain itemized deductions, taxable state and local tax refunds, accelerated depreciation of certain property, intangible drilling costs, certain tax exempt interest and the difference between AMT and regular tax gain or loss on the sale of property, treatment of incentive stock options and depletion allowances. [IRS]
  • LESS: AMT exemption
  • $45,000 for married filers, $35,750 for single filers
  • regardless of number of dependents
  • phased-out for high income individuals at a rate of $.25 for each $1 AMTI above $150,000 for joint filers ($112,500 for singles) [b]
  • exemption totally eliminated for joint filers with $330,000 ($247,500 for single)
  • Subtotal: Alternative minimum tax income (AMTI)
  • Rate Schedule
  • 26% on first $175,000, and 28% on the rest
  • 32.5% and 35% for individuals in the phase-out range
  • This tax liability is called tentative AMT
  • Taxpayer’s AMT = tentative AMT - regular income tax liability > 0
  • Total tax liability is AMT if tentative higher than regular tax liability.
  • Effects and Implications
  • AMT meant to be a class tax and not a mass tax.
  • However, by 2010 about 35 million taxpayers will be affected by the AMT and the cost of removing the AMT will be higher than the cost of repealing the regular income tax. [Tempalski, 2002, p. 342]
  • Why?
  • From the calculation of AMT tax, any relative decreases of regular tax liability with respect to tentative AMT liability causes AMT to kick in
  • Non-indexation of AMT parameters causes AMT to take effect
  • Regular income tax parameters are indexed for inflation
  • Decreases regular tax income relative to tentative AMT
  • Bracket creeping occurs as inflation moves individuals into a higher bracket even though real income (purchasing power) has not increased.
  • 2001 EGTRRA regular tax income cut
  • little changes to the AMT were made
  • causes the number of AMT taxpayers to double by 2010 on its own
  • Hypothetical Family in 2007
  • B: Figure 6 and 7, pg 13 for analysis
  • Distribution of AMT
  • B: Table 5, pg 13 for analysis

Analysis and Policy Recommendations

  • Equity
  • AMT exemption preferences are of greatest importance to middle income taxpayers for tax purposes
  • As AMT expands, these adversely affect modest income taxpayers, and not the very rich
  • Efficiency
  • Excess burden of income tax varies with the square of the marginal tax rate (CH 13)
  • Minimum AMT tax rate is 26%, considerably higher than the rates faced by households under the regular tax system
  • Complicated tax system
  • Families would have to engage in AMT tax forms to find out if need to pay the AMT tax
  • Applies even though not required to pay, adding to the burden of tax compliance.
  • Dual Accounting systems [b]
  • AMT preferences(e.g. depreciation and circulation expenses) have different amortization and depreciation schedules than the regular tax system
  • Two different accounting systems for these AMT preferences
  • Kiddie tax [b]
  • To determine the individual AMT liability for a child subject to the kiddie tax, a taxpayer must fillout a 17 and 18 line worksheet.
  • The child’s AMT liability can be affected if part of his parents’ AMT exemption is unused or if his paretns’ (or even a sibling’s) regular tax liability is greater than their tentative AMT liability.
  • Claiming AMT credits [b]
  • To use AMT credits to offset regular tax liability (or to carry forward unused AMT credits), must fill out a 42-line AMT form and the 28-line credit form for both the current and previous year.
  • Using regular tax credits [b]
  • Must fill out 10-line form to verify disallowance of tax credits
  • Majority of tax credits are available for use, but only certain after filling out form (and sometimes the 42-line form)
  • Solutions (?)
  • Raising the AMT exemption amounts
  • Lowers the tentative AMT tax level, thus reducing AMT tax liability
  • Effect of Indexing AMT Parameters (e.g. exemptions and brackets)
  • B: pg 18 and graph
  • refer to pg. 11 to describe graph
  • in 1997, those affected by AMT is just under .7% of all taxpayers with positive individual income tax liability.
  • The number affected is estimated to grow at 29% annually
  • In 2007, those affected will represent 9%.
  • AMT elimination
  • More logical to remove high-income taxpayers’ tax shelters in the regular tax system than doing so in a new tax system

The complexity of the AMT has extensive implications on taxpayers’ efficiency as well. The excess burden of an income tax is known to vary with the square of the marginal tax rate. The lowest AMT tax rate is 26%, considerably higher than that of the regular tax system that most families face. As these families are thrown into the AMT, their excess tax burden will greatly increase. By 2010, the AMT will impose higher marginal tax rates for 93% of AMT taxpayers, resulting in potential tax avoidance and disincentive to work (Burman, Gale, and Rohaly). The system will also complicate taxpayers’ tax procedures by mandating more tax forms to fill out. Households must fill out these tedious forms regardless of whether they have to pay the AMT, resulting in the greater burden of tax compliance (Rosen).

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