The Alternative Minimum Tax and Tax Reform

Lawmakers have added a lot of tax preferences and financial incentives into the Tax Code over the years, but with one hand Congress giveth, and with the other they taketh away. If filers are eligible for too many breaks written into the law that reduces one’s tax obligation, they get to recalculate their taxes a second time under a separate system of rules. Welcome to the Alternative Minimum Tax (AMT). The White House’s broad plan to reform and simplify the Tax Code includes a proposal to eliminate the AMT, an attempt at eliminating compliance burdens that is costly in both time and money.  

Congress enacted the first minimum tax in 1969 after outrage over reports that 155 wealthy individuals ended up with no income tax liability because of legal tax deductions. The AMT, as we know it today, was enacted in the Tax Equity and Fiscal Responsibility Act of 1982. This tax was to ensure that wealthy individuals were paying at least some income tax and were not able to entirely zero out their tax liability through various deductions and credits available in the tax code.

The AMT requires certain taxpayers to essentially figure out their taxes twice; once under traditional income tax rules and again under AMT rules. Usually taxpayers must complete additional forms to determine whether the AMT will apply to them. After doing so, they then proceed to fill out two different tax forms to determine what they owe federal government.

When filing taxes under the traditional income tax rules, these taxpayers may reduce their income tax liability by utilizing credits and itemized deductions, such as the deduction for taxes paid to state and local governments, real estate taxes, or personal property taxes, and other “miscellaneous itemized deductions.” However, when filing taxes under the AMT rules, taxpayers may only apply a handful of deductions and adjustments, including the charitable deduction, a limited mortgage interest deduction, and the AMT standard exemption, which for 2016 was $53,900 for individual filers and $83,800 for joint filers.

After jumping through these mathematical hoops, taxpayers arrive at a calculation of their AMT taxable income. This income is then taxed on a tiered-rate structure of 26% and 28%. This 28% tax rate is lower than the highest traditional individual income tax rate of 39.6%.

Most people are probably unfamiliar with the AMT, and thus, may not realize they may be subject to it. Because taxpayers cannot always know when they are required to pay or even file AMT paperwork (including people who use tax filing software), the AMT complicates tax planning. If a filer plans on reducing their AMT burden, they could end up increasing their burden under the regular tax. Moreover, because it is difficult in advance to determine what rate a taxpayer will ultimately pay, the AMT decreases transparency and simplicity in the Tax Code, making it difficult to determine whether somebody is paying “their fair share.”

The AMT raised $28.6 billion in tax revenue in 2014 – approximately 1 percent of all tax receipts that year – from over 4.3 million filers. (An additional 4 million filers filled out AMT forms but were not ultimately subject to it). The minimum tax was originally targeted at high-income earners taking advantage of loopholes, but its impact primarily falls on those just below that level. As the Taxpayer Advocate noted:

Today’s AMT primarily affects taxpayers for paying state and local taxes and having children. While it is hard to imagine the drafters of the original AMT provision would view the expenses of having children or paying local taxes as tax-avoidance loopholes, that is how those expenses are treated today.

According to the latest data from the IRS, those earning $200-500 thousand file over 70 percent of the AMT forms, and are liable for over half of all the AMT tax revenues.

Under the Paperwork Reduction Act, federal agencies are required to report an estimate of how much time must be spent by the public complying with their government-mandated record keeping and data collection. As NTUF reported in its latest report on tax code complexity, filers spent a total of 6.989 billion hours complying with the tax code in 2015. However, there is a surprising lack of recent data regarding the paperwork burden of the AMT on taxpayers.

In 2013, the Taxpayer Advocate cited an IRS estimate from 2000 that taxpayers spent over 18 million hours complying with the AMT forms, over 12 hours per person who was liable for the tax that year. It’s unclear whether this burden has grown since then with the five major AMT-related laws that have been passed since 2005, or whether tax preparation software has lessened the time burden.

Under the simplified tax system envisioned in tax reform plans offered through the President’s blueprint or through the House GOP’s “A Better Way” plan, the AMT’s double-tax filing system would no longer be necessary. Taxpayers would see a Tax Code that is more efficient, simpler to understand, easier with which to comply.