Understanding changes to the alternative minimum tax
By MARC GOLDFISCHER

 

Late last year Congress passed legislation to modify the dreaded Alternative Minimum Tax (AMT) – sometimes referred to as the “stealth” tax for sneaking up on millions of unsuspecting taxpayers as their returns are prepared.

While there has been a fair amount of media coverage on the so-called AMT “patch,” the AMT still remains one of the least understood areas in the tax code. It has been particularly confounding to those who have found themselves subject to a “new” tax even when their income or deductions haven’t appreciably changed from prior years.

The good news during this past 2007 filing season was that many taxpayers saw relief from the AMT. The bad news is the patch only provided a one-year reprieve.

Originally passed in 1969 when tax shelters were proliferating, the AMT was intended as a measure to ensure that wealthy taxpayers – who took advantage of tax shelter attributes or with large deductions for investment losses, capital gains, interest expense or utilization of tax credits – would pay a minimum amount of tax.

For the 1970 tax year, for example, the AMT impacted just 20,000 personal returns in the entire U.S. At that time, eight tax preferences were defined and to the extent that the sum of these preferences exceeded $30,000, a 10 percent minimum tax was applied to the excess and “added-on” to the normal tax calculation. To give you an idea of the original intent, $30,000 in 1970 dollars is the same as $162,000 in today’s dollars. To frame those figures even further, the top 20 percent of U.S. households today have gross income of more than $97,030; and the top 5 percent of households have gross income of more than $174,000.

In the mid 1980s, Congress saw fit to change the AMT calculation from an “add-on” to a “parallel” tax system de-emphasizing tax shelters and special treatment of preferential income and focusing on disallowing personal and dependent exemptions, state and local taxes and miscellaneous deductions in addition to the other traditional preferences. With the further phaseout of the AMT exemption as income increases and the effects of inflation and the non-indexing of the AMT calculation, lower- and middle-class taxpayers have now been snared by the AMT. Prior to 2000, the AMT impacted less than 1 percent of all taxpayers, according to the Congressional Budget Office. In 2006, the number grew to an estimated 4 million households. Assuming no change in the present law, that figure is expected to burgeon to more than 30 million taxpayers by 2010, each facing an estimated average $2,000 increase in their personal tax liability, according to U.S. Treasury Department estimates.

While many people debated the fairness of the original intent of the statute, one element of the AMT was patently unfair: It was the only federal income tax not indexed to inflation.

Without the patch that Congress approved in December, the 2007 tax year exemptions would have fallen to $45,000 for joint filers and $33,750 for single filers. The patch for the 2007 tax year raised those exemptions to $66,250 and $44,350 for joint and single filers, respectively, which effectively saved millions of taxpayers from this added tax.

If you’ve been granted some reprieve through this act of Congress, congratulations. For those who haven’t filed and are on extension and still find yourselves subject to the AMT for the 2007 tax year, there are a few things you should note: The application of some credits has changed. Both your entire tax and AMT tax liabilities may be offset by nonrefundable personal credits. Credits such as child care, dependent care, elderly or disabled care, education credits or home energy credits can now be used to offset both “regular” and AMT tax liabilities.

AMT refundable credits are more generous. Long-term (dating back more than three years) AMT credits, also known as minimum tax credits (MTC), are entitled to better treatment. They can be used in amounts equal to the greater of a) $5,000; b) 20 percent of the unused MTC; or c) the AMT refundable credit for the prior tax year.

If Congress takes no action going forward, projections indicate that more than 26 million taxpayers will be subject to this tax in the coming year and that by 2010 the AMT will become the “de facto tax system” for approximately 93 percent of individuals with incomes of $100,000 to $500,000 annually as well as severely impacting middle-class taxpayers earning $50,000 to $100,000. Hopefully Congress will mitigate a potential tax crisis in the near future.

 

 

Marc Goldfischer is a managing director in the tax group of UHY Advisors’ Rye Brook office. Reach him at mgoldfischer@uhy-us.com.

 

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