The Alternative Minimum Tax - Red vs. Blue

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KenO’Brien
NEWS UPDATES Dec. 7 -
Taxfiling delay looms if no fix for minimum tax: IRS
IRSChief Warns Again About AMT Hit

If you aren't familiar with the alternative minimumtax - commonly known by its initials, AMT – you might want to get acquainted with it. Congresscreated the AMT back in 1969 to make sure that certain high-income citizens couldn't skip outon paying taxes altogether by gaming the system. So under the present regime, you pay eitheryour regular taxes or the AMT (which is essentially a flat rate that eliminates mostdeductions), whichever is higher. A definite hassle (because you have to calculate your taxes twice),but at least it sounds fair, right? 
Well, there's one major problem: The AMT is not indexedfor inflation. In other words, the income level at which you potentially trigger theAMT has been unchanged (apart from occasional Congressional band-aids) over the years.Seems like a pretty glaring and obvious mistake to me, but there it is. When it was firstpassed, only a tiny handful of people were potentially subject to the AMT - just a fewthousand, all of whom could fairly be described as upper-income.
But millions more Americans could be subject to theAMT in their 2012 returns if Congress fails to reach a deal on the fiscal cliff before year-end.That's because the AMT is currently scheduled
to hit individuals making as little as$33,750 a year and joint filers making $45,000.
However, the usual vehemence heard over taxes fromthe Republicans as well as the concerns
over middle class tax rates championed by the Democrats seem to have been lostover this issue.
In large measure part of the problem is purelypolitical. Each side sees itself as having leverage
in the fiscal cliff debate when it comes to the AMT. That is a direct result ofthe geographic
impact of the tax.

As NEWSMAXreported on December 4th, “U.S. Republicans may have some leverage in theirfiscal cliffhanger with President Barack Obama: the threat of forcing adisproportionate number of Democrats to pay the so-called alternative minimumtax.
“Under U.S. law, taxpayers each year must pay the greater of regular federalincome tax, or the AMT. The latter requires taxpayers to give up certain taxbreaks, typically exemptions and deductions for state and local taxes andmedical costs….
“States with the wealthiest taxpayers and the steepest state taxes, whichtypically cannot be deducted under the AMT, include New York, California andIllinois - Democratic strongholds.”
The issues are crystallized in a report issued byThe Congressional Research Service on December 4^th titled Alternative MinimumTaxpayers by State: 2009, 2010, and Projections for
 2012. It breaks downstates by the percentage of taxpayers in each who are subject to the Alternative Minimum Tax. Anyone with any familiaritywith the recent election and the Geographical distribution of Democratic vs.Republican strength will see a clear pattern.

Political Color Scheme Added

A 2005article in the Orlando Sentinel nicely stated why those in the redstates would favor maintaining the AMT.
Thoseof us who live in what the politicians in Washington, D.C., call the red statesought to think twice when we hear them talk of repealing the AlternativeMinimum Tax.That'sbecause those folks want to put one over on us by repealing a levy we in thered states pay less frequently, with the likelihood of replacing it with onethat would cost us more.Thisbizarre reality stems from the AMT being the only tax that discriminates basedon geography among those with similar incomes.There'salso a political twist. Republicans generally want to cut taxes, whileDemocrats are more skeptical because they want more government spending.Buton this one, the situation is much more complex because of how the tax falls.Everystate that voted for President Bush in 2004 would be net losers if the AMT isrepealed and another sales or income-based tax were created to capture thatrevenue. Those in most states that voted for John Kerry would be net gainers.That'swhy when you hear the politicians in D.C. talking about making the tax systemmore fair, make sure you ask them: Fairer for whom?Thinkof the AMT as an alternative, and higher, federal income tax. It has differentrules for deductions and credits than the one most of us live under. Thededuction for a state income tax makes the most difference in creating thisgeographically uneven playing field.Thosewho pay the AMT can't write off state income or sales taxes, as other filerscan. In addition, there are a series of other deductions and exemptions --disproportionately enjoyed by those who live in the blue states -- that areavailable to most taxpayers that do not count for those paying the AMT.Statesthat voted for Bush are much less likely to be hit by the levy because thoseare the same states where the politicians in power (mostly Republican) havecreated a system of either minimal or no income taxes. In addition, thosestates, because of living costs, tend to have lower salaries for jobs that paymore elsewhere.
However, if the Congress fails to address thelurking consequences of failure to fix the AMT, this perceived advantage could rapidlyturn into a liability. The Congressional Research Service study notes:

In 2010, 4.02 million taxpayers weresubject to the AMT, a slight increase from 3.88 million taxpayers in 2009. In 2010, New Jersey, Connecticut, the District of Columbia,and New York had the highest percentage of taxpayers subject to the AMT. Mississippi, Tennessee,Alabama and South Dakota had the lowest percentage of taxpayers subject to the AMT.

In2012, absent an increase of the AMT exemption amount, 32.4 million taxpayerswill be subject to the AMT. At that time, whether a married taxpayer has itemized deductionsfor state and local taxes or miscellaneous deductions will become a much less important factor thanit is at present in determining AMT coverage. This occurs because, whether theyitemize their deductions or not, married taxpayers across a wide range of incomes will be subject to the AMTbecause personal exemptions are not allowed against the AMT.
According to  William Perez, the alternativeminimum tax exemption amounts for 2012 are scheduled torevert to the following levels:
$33,750 for single and head of household filers,$45,000 for married people filing jointly and forqualifying widows or widowers, and$22,500 for married people filing separately.
When calculating the alternative minimum tax,various adjustments are made. Some income is added which is not subject to theregular tax. Some deductions are adjusted downwards or eliminated entirely.

The following items may trigger an AMT liability:Itemized deductions for state and local taxes,medical expenses, and miscellaneous expenses
Mortgage interest on home equity debt
Accelerated depreciation
Exercising (but not selling) incentive stock options
Tax-exempt interest from private activity bonds
Passive income or losses
Net operating loss deduction
Foreign tax credits
Investment expenses
AMT Tax RatesThe exemption amounts mean that this amount of AMT taxableincome is not subject to the AMT. Income over these amounts may be subject toAMT. Unlike the ordinary tax rates, the AMT has only two tax brackets. The AMTtax rate is assessed only on AMT income over the exemption amount. The AMT taxrates are:

• 26% on the first $175,000 of AMT taxable income, and
• 28% on the remainder of AMT taxable income

This is opposed to the following marginal rates forthose to whom the AMT does not apply:(Each tax rate applies to a range of income, whichis called a tax bracket. Each tax rate applies to a specific range of taxableincome, which is income after various deductions have been subtracted.)SingleFiling Status10% on taxable income from $0 to $8,700, plus15% on taxable income over $8,700 to $35,350, plus25% on taxable income over $35,350 to $85,650, plus28% on taxable income over $85,650 to $178,650, plus33% on taxable income over $178,650 to $388,350,plus35% on taxable income over $388,350.

MarriedFiling Jointly or Qualifying Widow(er) Filing Status10% on taxable income from $0 to $17,400, plus15% on taxable income over $17,400 to $70,700, plus25% on taxable income over $70,700 to $142,700, plus28% on taxable income over $142,700 to $217,450,plus33% on taxable income over $217,450 to $388,350,plus35% on taxable income over $388,350.
Clearly a comparison of the alternative ratesindicates a distinct disadvantage for lower income wage earners.

This chart shows that, by the CBO’s calculation, families earning a poverty-level amount of money can face marginal tax rates of up to 60 percent.


If at first that doesn’t seem remarkable, considerthe current political drama over the fate of the “Bush tax cuts” for top incomes. That dispute concerns whether the top ratewill go up from 35  to 39.6percent. If families earning $250,000 a year taxed at a top rate of about 40percent is cause for concern, clearly a 60 percent rate for afamily of four making $23,050 (which would put them right at the federal poverty level) is aproblem.
Another problem, of course, is that people mightstop working altogether because of the incentives they face. The CBO report doesn’t includeestimates of marginal tax rates facing the unemployed, because they don’t have tax return datathat can be analyzed. But at such low levels of income, it’s not hard to imagine people becomingdiscouraged by the low returns to work.
The President’s FY2013 Budget proposes analternative budget baseline where the AMT is permanently indexed for inflation based on 2011parameters.*



So the opening question remains – will the fate oflower and middle income wage earners become hostage to  the AMT in the fiscal cliff negotiations?

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Note:The ranges in red are the phaseout bands. The rates are higher because you loseAMT exemptions as your income goes up. If you are subject to AMT, remember yourmarginal tax rate can be higher than what you think it is. Since state incometax is not deductible under AMT, to get your combined federal and statemarginal tax rate, just add your marginal state income tax rate to the federalrate when you are under AMT.