Alternative Minimum Tax (AMT) – perhaps the most serious problem and most burdensome aspect of the American tax code – was established to tax millionaires who avoided paying taxes by taking advantage of loopholes. An estimated 96 percent of AMT taxpayers now have incomes under $1 million while many millionaires still manage to pay little or no taxes at all.
The White House said that 55,000 millionaires manage to pay a lower effective tax rate than millions of middle-income Americans. And according to the IRS, nearly 21,000 taxpayers with adjusted gross incomes of more than $200,000 paid no income tax at all – over 35,000 taxpayers if you use a more expanded definition of income.
For the majority of its existence, AMT was not indexed to inflation, limited to high income taxpayers, or focused on tax loopholes. Because of this, it has morphed into a tax that increasingly targets middle income taxpayers.
The AMT is a second tax system which parallels the regular federal income tax system and requires taxpayers to compute their taxes twice – once under the regular tax rules and once under AMT rules.
Taxpayers have to hit a certain income threshold before being subjected to the tax. If the amount you owe under AMT rules exceeds the amount owed under regular tax rules, the taxpayer pays the difference as AMT, in addition to regular taxes.
One step in the right direction for AMT reform was the American Taxpayer Relief Act of 2012, which finally indexed the AMT to inflation. The income threshold -- $50,600 for single individuals and $78,750 for married taxpayers filing jointly -- will now automatically increase each year and if you don't pay it this year, you won't likely have to worry about it anytime soon.
But even indexing the AMT to inflation ignores the bigger problem: the AMT was never intended to tax the middle class, or anyone other than the extremely wealthy 1 percent.
“The AMT applies now to middle class taxpayers and it was never suppose to, yet we are still having the debate whether high income people are paying their fair share of that,” said Steve Peace, chairman of the board of directors for the Independent Voter Project.
It seems like a simple enough solution: repeal the AMT. So, what's stopping legislators from doing just that?
Many argue that repealing the AMT without offsetting the cost could add trillions to the federal debt within a decade.
According to Peace, Republicans and Democrats have too much money to lose by repealing AMT. It's also an easy way for them to pander to their constituents and maintain the illusion that they are working hard for their voters.
“Republicans want to pretend as if they want tax cuts, while Democrats want revenue and federal services,” he said.
In 2012, AMT generated $57.5 billion, according to the Tax Policy Center.
Others argue that repealing AMT would be a good thing for the economy, claiming that doing so would increase fixed investments, raise the GDP, expand capital stock, increase labor productivity, and reduce the cost of capital.
The real question is not how repealing AMT will affect the economy, according to Peace, but “whether or not we should continue to allow a stealth sneaky tax to exist that people don't generally understand which was never intended to be a revenue generator in its inception.”
“What's objectionable about the current structure is that it's not transparent, honest, or open and has the result of having states like California and New York acting like giant subsidiaries for the rest of the country,” Peace said, adding that in order to shrink the tax code by thousands of pages, he believes we should “pass a constitutional amendment saying that members of Congress have to fill out their own tax returns with no professional assistance.”