One-Fifth Of All Americans Could Be Hit By Alternative Minimum Tax In 2012
A Congressional Research Service (CRS) Report entitled “The Alternative Minimum Tax for Individuals” is an eye-opener regarding the potential reach of the alternative minimum tax (AMT).
The report examines the combined effects of not having inflation-adjusted AMT exemption amounts and the pending expiration of the regular income tax cuts from 2001 and 2003.
As background, AMT is the excess of your "tentative minimum tax" over your regular tax for the year. In arriving at tentative minimum tax, you begin with taxable income, modify it with various adjustments and preferences, and then subtract an exemption amount (which phases out at higher income levels).
The result is alternative minimum taxable income (AMTI), subject to an AMT rate of 26% or 28%.
For 2012, the individual AMT exemption amounts fall, unless Congress retroactively changes them, to $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for marrieds filing separately.
The 2001 and 2003 tax cuts provided temporary increases in the AMT exemption amounts as a means of limiting who would owe AMT. These amounts have since been "temporarily" extended and increased over the years by a succession of tax laws (the so called AMT “patch”), but those temporary extensions are once again set to expire.
Similarly, the ability of individuals to use most nonrefundable personal credits to offset AMT has also been temporarily extended over the years so that individuals have been able to use most such credits to offset AMT.
Thus, for example, in 2011 you could offset your entire regular tax and AMT liability by the nonrefundable credits. Unless there's a law change, beginning in 2012 many nonrefundable credits will only be allowed against your regular income tax.
The rule allowing nonrefundable credits to reduce the AMT (as well as regular tax) benefits middle income individuals who: (a) have low taxable income and thus a low regular tax (for example, because of a large number of personal exemptions); (b) are subject to the AMT because personal exemptions (as well as the standard deduction and certain itemized deductions) generally aren't allowed in computing the AMT; and (c) have substantial nonrefundable credits.
Here’s the wake up call. The CRS Report notes that unless Congress acts, the combined effects of inflation and the reductions in the regular income tax will cause roughly one-fifth of all taxpayers to be hit by the AMT in 2012!
Despite the individual tax rate reductions and the marriage penalty tax relief provisions of the 2001 and 2003 tax cuts, many in the middle income ranges will find that when they file their 2012 returns, the AMT will "take back" much of the tax benefit contained in the tax cuts.
Why is this? Simply put, under the regular income tax, the tax rates, standard deductions, personal exemptions, and other items are indexed so that they do not lose their real (inflation-adjusted) value over time. However, the components of the AMT are not indexed for inflation.
This problem has long been recognized. In 1997, 605,000 taxpayers or roughly 1% of all taxpayers were subject to AMT. In 2009, 3.8 million or about 2.7% were subject to AMT.
Estimates indicate that in 2012 (when the latest patch expires), over 30 million taxpayers will either fall under the AMT or have AMT limits on their tax credits under the regular income tax. By 2020, an estimated 58 million taxpayers will be affected.
A quick fix for the looming problem would be yet another temporary patch. The CRS Report, however, concludes that Congress should consider modifying the tax system if it wants to: (1) retain the social and economic incentives in the Code while maintaining the concept that everyone should pay at least a minimum level of income tax; and (2) limit the number of taxpayers subject to the AMT.
Modification would involve two primary issues: inflation and AMT coverage.
As for inflation, indexing the AMT for inflation (perhaps the most important change that could be made) would allow a consistent separation of the two tax systems (the regular income tax and AMT) to be maintained over time, and would result in substantially reducing the number of taxpayers projected to be affected by AMT in the future.
The second issue concerns the coverage of the AMT.
Originally, the AMT was intended to cover only ultra high-income taxpayers. However, changes to the Code since it was first introduced have markedly increased the availability of special tax preferences to taxpayers in the middle and upper-middle income range. The CRS Report notes that this is likely to produce large differences in the tax liabilities of otherwise similarly situated taxpayers in these income ranges.
A major strike against a fix is the cost. Any permanent fix to the AMT would be expensive.
The CRS Report notes that there are several reform proposals to deal with the AMT problem, including repeal. But, if the AMT were repealed without adjustments to the regular income tax, the lost revenue would be huge.
