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Deconstructing the Alternative Minimum Tax

by James M Bennett, published
credit: Tax Policy Center

alternative minimum tax

About forty years ago, Congress decided that rich people were receiving too many breaks from tax loopholes and preferences that it had previously given them. So rather than address the breaks, loopholes, and preferences, Congress papered them over with a parallel tax system called the Alternative Minimum Tax (AMT). Such legislative slothfulness characterizes not only the AMT, but other segments of the Internal Revenue Code.

The facile solution chosen by Congress in the AMT as a method to make the rich pay up foisted an opposite and disproportionate burden on the taxpayer. The calculation of the AMT for individuals is daunting. At the end of the process, taxpayers must pay whichever tax is higher - the regularly calculated tax or the AMT.

After individuals first calculate their tax the regular way, along comes Form 6251. That form begins with 25 lines of add-backs to adjusted gross income (AGI), at least 11 of which require the taxpayer to calculate each particular segment of the tax base both the regular way and the AMT way and enter the difference.

Then comes the exemption. It's as if Uncle Sam were saying, "I gave you these tax preferences, but I didn't really mean to, since you're rich. So I'm taking them away from you. But I'm letting you keep some preferences in your tax base - up to a point."

The point is discernable with difficulty. To keep eyes from glazing over, let us just consider a pair of married taxpayers filing jointly with an AGI of $200,000, calculated the higher AMT way of course. The couple this year can exempt $78,750 less 25% of the amount by which their AMT taxable income (TI) exceeds $150,000. In other words, this couple can exempt $66,250 of tax preferences from the tax man, leaving, for now, $133,750 of TI subject to the AMT.

In 1969 the exempt amount was $30,000. That was a lot of money in 1969, equivalent to nearly $190,000 today. The exemption clearly has not kept pace with inflation and also does not consider metropolitan areas where higher incomes merely compensate for higher costs of living.

But wait. We're not done. If the couple had "qualified" dividends or capital gains, there is a mini Schedule D on the back of Form 6251 with another 18 lines of computation, not including feed-in worksheets. Qualified dividends and capital gains have to be re-figured for the AMT. The form cannot be completed without reference to five forms and one statute outside of its four corners.

The rate is 26% on AMT TI up to $175,000. Excess TI is subject to a rate of 28%. Subtract the personal exemption (different from the AMT exemption). [See form 6251, Line 31.]

Mark Twain anticipated the AMT, and the Internal Revenue Code generally, when he wrote, "I didn't have time to write a short letter, so I wrote a long one instead." If Congress would have had the rigor to directly address the miscreant tax preferences, breaks and loopholes, there would have been no need for the AMT and the code would have been shorter. Now Congress has created yet another babysitting obligation for itself to assure that the tentacles of the AMT do not reach down to the middle class. Congress has lain down on that job. The percentage of married couples with children paying AMT was once projected to be 39 percent without a recent patch.

In 2010, AMT revenue was $102 billion, being about 9.4% of revenue from the individual income tax and 4.7% of total tax revenue. With marginal additional effort, Congress could have raised the same, or more, revenue by instead addressing preferences, exemptions and loopholes directly. Surely there are some of those to be found among the 73,608 pages of statutes, regulations and revenue rulings that make up the CCH Standard Federal Tax Reporter for 2012.

Suppose a tax system could be created that has no preferences, breaks and loopholes in the first place? There would be no need for an AMT. Actually, one has. It is called the FairTax. The FairTax is a bill in Congress with 60 sponsors that replaces Subtitles A, B, and C of the Internal Revenue Code with a national retail sales tax on all new tangible goods and all services. [See HR-25, S-122.] The bill phases out the IRS. There are no exemptions from the tax because the regressivity problem is handled instead with a prepayment from the Social Security Administration to cancel out the tax on necessities. The prepayment, based strictly on household size - not income, goes to all U.S. citizens and lawful residents. The bill is HR-25 and S-122.

Because there are no exemptions, there are no preferences, breaks or loopholes. Consumers readily see that, if particular goods were to be exempted, other goods would have to make up for the shortfall. Therefore with the FairTax, "AMT-creep" (i.e. creeping into lower tax brackets due to inflation) becomes unlikely. With the FairTax, legislative slothfulness would actually be a good thing. With one easy legislative stroke on a bill that already exists, Congress could demonstrate sincerity about tax reform.

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