Is the AMT in need of a fix?

New Jersey ranks first among the states in the percentage of Alternative Minimum Tax filers.  273,589 New Jersey taxpayers, 6.5% of all New Jersey taxpayers paid the AMT in 2006.  The Joint Committee on Taxation projects that without another legislative patch or AMT reform, more than 1.6 million New Jersey taxpayers, about one-third of all New Jersey filers, could be required to pay the Alternative Minimum Tax in 2008.

Congress enacted the first minimum tax, following testimony by the Secretary of the Treasury, that 155 people with adjusted gross income above $200,000 (about $1.1 million in today’s dollars) had paid no federal income tax on their 1967 tax returns.  More than forty years later, the Alternative Minimum Tax has evolved from a 10% add-on tax on a few high-income filers to a true alternate income tax regime that now affects many solidly middle class taxpayers. Today, 66% of AMT taxpayers have adjusted gross income between $100,000 and $300,000.

The AMT is no longer targeted at tax shelters.  Personal exemptions, itemized deductions for state/local taxes, and miscellaneous itemized deductions account for 96% of the preference items that are subject to tax under the AMT, but not taxed under the regular income tax.

In 2007, 23 million taxpayers were expected to pay AMT.  The 2007 AMT extender passed late last December kept the number of AMT taxpayers at around 4 million, but at a cost of more than $40 billion.  In 2008, 25.7 million taxpayers will be affected by the AMT unless there is AMT reform or repeal.

Why are increasing numbers of taxpayers exposed to the AMT?  First, unlike the regular income tax, the AMT has not been indexed for inflation.   The Economic Recovery Tax Act of 1981 cut taxes and indexed the regular tax system for inflation, but did not index the AMT.  Only the most recent AMT relief extenders have adjusted the AMT’s standard exemption to match the real dollar value of its 1993 level.  The AMT rate brackets, however, remain unchanged.

The other reason for the AMT’s expanding reach, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), and the Working Families Tax Relief Act of 2004 (WFTRA) , cut regular income tax rates, but did not make significant permanent changes to the AMT.  This increased the number of AMT taxpayers, but those taxpayers generally pay less under the AMT than they would have paid under the regular income without those tax cuts.

The AMT was purposefully left unadjusted by EGTRRA.  Congress calculated that the AMT would “clawback” the 2001-2003 tax cuts for many upper middle class taxpayers masking the revenue costs of its top bracket rate cuts.  Indeed, by 2010, the AMT is presently scheduled to recapture about 29 percent of the overall EGTRRA tax cut, including more than 71 percent of the cut targeted to taxpayers with income between $200,000 and $500,000.

The expiration of most of the 2001-2003 tax cuts in 2011 would cut to 18 million the projected number of AMT taxpayers.  But without change, the AMT will hit 39 million by 2017.  If, instead, the tax cuts are extended, 53 million taxpayers, nearly half of all taxpayers, could pay the AMT in 2017.

There is a broad range of options for reforming the AMT.  Different options will affect taxpayers with different income levels or tax characteristics differently and will lose varying amounts of revenue.

The AICPA, the Tax Executives Institute, the National Taxpayer Advocate, the Section of Taxation of the American Bar Association each advocates the repeal of the AMT.  However, outright repeal of the AMT gives rise to a tremendous loss of federal revenue.

The Congressional Budget Office and the Joint Committee on Taxation estimates that repeal of the AMT would reduce federal tax revenues by more than $600 billion over the next ten years.   Assuming the 2001-2003 tax cuts are made permanent, repealing the AMT without offsets would cut federal tax revenues nearly $950 billion over the next decade.

The AMT could be retained, but be indexed to minimize its creep.  Recent temporary fixes have effectively indexed the AMT exemption.  Permanently indexing the exemption, rate brackets and phase-out limits would significantly reduce the growth in the number of AMT taxpayers.  The Tax Policy Center projects there would be 4.6 million AMT taxpayers in 2010 if full indexing were adopted.  The cost of indexing over 10 years: about $420 billion under current law or $950 billion if the 2001-2003 tax cuts are extended.

Other possible changes would eliminate differences between the AMT and the regular income tax:

  • allowing AMT itemized deductions for state and local taxes and home mortgage interest.
  • conforming the deduction floor for medical expense deductions under the AMT to the regular income tax.
  • allowing miscellaneous itemized deductions.
  • allowing the dependent exemptions.

All of these proposed changes lose significant revenues and present a high hurdle to achieving needed reform.  Instead, repeal or reform of the AMT may have to be part of a complete revamping of the entire federal income system.