Video: AMT awareness

By Martin Wolk Executive business editor
msnbc.com
updated 6/24/2005 7:19:09 PM ET 2005-06-24T23:19:09

Conservatives hate it, liberals revile it, taxpayers agonize over it, but the alternative minimum tax is a handy thing to have around.

For Congress, the AMT offers a stream of theoretical revenue that makes tax-cut proposals seem relatively cheap under Washington’s budgetary “scoring” rules. Much of the expected revenue — which totals an estimated $670 billion over the next decade — likely will never materialize because Congress presumably will act to prevent millions of middle-class families with children from suffering the AMT’s stealth tax increase.

For the Bush administration, the AMT serves as a convenient whipping boy, illustrating the unfairness and complexity of a tax system the White House believes needs reform badly. President Bush has not said who would pay for fixing the AMT but has appointed a panel chaired by former Republican Sen. Connie Mack to come up with recommendations by the end of July.

The alternative minimum tax already affects nearly 3 million taxpayers, up from fewer than 200,000 in 1990. Originally designed to catch just 155 super-wealthy Americans who paid no taxes at all, the AMT now reaches well into the upper end of the America’s middle class, with most of those affected reporting income of $100,000 to $500,000.

But that is nothing compared to what would happen if Congress fails to act in the current session.

Unless something is done, some 20 percent of taxpayers will be caught in the AMT net next year, up from 4 percent currently. By 2010, “virtually all” middle-class families with two or more kids will be subject to the tax, according to Len Burman, co-director of the Urban-Brookings Tax Policy Center in Washington.

“The alternative minimum tax is reaching more and more each year, to the point where it is grabbing a lot of taxpayers at all income levels,” said Ross Rizzo, a certified public accountant and director of taxes and for Salibello & Broder in New York.

Nina Olson, the Internal Revenue Service’s national taxpayer advocate, identified the AMT as the nation’s No. 1 tax problem in 2003, saying it appears to function “randomly, no longer with any logical basis in sound tax administration or any connection with its original purpose of taxing the very wealthy who escape taxation.”

The tax is insidious and not only because it can cost middle- and upper-middle class workers hundreds or thousands of dollars in additional taxes. A stealth tax that operates as a parallel system, virtually unfathomable to laymen, the AMT makes a mockery of tax-planning strategies typically used by middle-class wage-earners.

“It raises a very serious complexity issue,” said Robert Carroll, deputy assistant Treasury secretary for tax analysis. "Individuals who are hit by the AMT are often unaware of it until they are hit by it the first time.”

Consider the case of Art and Erin Swadener, a middle-class couple with two young children in Bonita, Calif., near San Diego. They enjoyed a windfall last year when they sold their tract home in nearby Chula Vista — which she described as ordinary — for $730,000, generating a $300,000 capital gain after only 16 months of ownership.

That, by the way, is not an atypical event in the crazy-hot California housing market, said the Swadeners’ accountant Leonard Wright, a personal financial specialist in Los Angeles.

The Swadeners set aside $55,000 to pay the anticipated capital gains tax, still leaving them plenty of capital to move into their $1.1 million dream home. But even though Erin Swadener is a real estate agent, neither she nor her (former) accountant realized the one-time gain would push them into AMT territory, resulting in an additional tax hit she estimated at $60,000 to $75,000.

“I think we would have waited to our two-year mark (in the home) if we had known the full extent of the tax liability,” she said.

Or consider Norma and Ed Hasselman of Solana Beach, Calif., a retired couple in their 60s who had income of around $75,000 last year but still had to pay alternative minimum tax. Certain expenses they claimed as deductible under the regular tax regime, including legal fees from a lawsuit, were disallowed under the alternative minimum tax, which they had to pay.

Norma Hasselman said the couple had paid the AMT in the past when they had a one-time gain from the sale of a business, but she “was totally unaware” it could affect people with such relatively modest incomes.

She was particularly frustrated because the AMT makes it that much harder to figure out how much to withdraw from tax-deferred retirement accounts like IRAs. “An ordinary person needs a tax expert to avoid being double-taxed,” she said.

To be sure, it is hard to feel too badly for either the Swadeners or the Hasselmans. The Hasselmans ended up paying only a few hundred dollars in extra taxes, said their accountant Melody Thornton, tax manager at J.H. Cohn LLP in San Diego. “It wasn’t huge, but it shouldn’t have been anything at that level,” she said.

As for the Swadeners, they intend to sell their current home after living there only a year and will realize another capital gain of $200,000. They plan to move “down” to a $930,000 property with more land, a smaller mortgage and much lower property taxes. “We’re pretty good investors,” Erin Swadener said.

The point is that the alternative minimum tax was never designed to catch middle-class taxpayers like the Swadeners or Hasselmans.

But because the AMT exemption has never been indexed for inflation, more and more taxpayers get pushed into it every year through “bracket creep.”  The tax cuts of 2001 and 2003 vastly increased the reach of the AMT since taxpayers generally have to calculate their taxes both ways and pay the higher amount.

And Congress so far has chosen a Band-Aid approach that keeps future revenues on the books. In 2004 and 2005 a temporary measure exempts all income below $58,000 for couples and $40,250 for single filers from the alternative minimum tax. But next year the exemptions fall back to $45,000 and $33,750, which would mean higher taxes for a projected 17 million taxpayers who would be thrown into the AMT.

According to projections of the Tax Policy Center, if Congress fails to act in time for the 2006 tax year, the AMT will affect 77 percent of couples with at least two children and income of $75,000 to $100,000.

“Congress must address the AMT before it bogs down tax administration and increases taxpayers’ cynicism to such a level that overall compliance declines,” said the IRS’ Nina Olson in her report.

Burman, of the Tax Policy Center, is skeptical Congress will come up with a permanent solution.

“They will come up with a stop-gap solution,” he said. “I can work until I’m 100, do the same AMT paper over and over, and trust Congress never to take away my bread-and-butter issue,” he said.

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