Growing numbers facing 'rich' tax: Alternative minimum tax reaching middle class

January 9, 2006

The number of Americans subject to the alternative minimum tax is expected to skyrocket this year unless Congress passes a retroactive safeguard.

The tax, designed to prevent the rich from skirting taxation, threatens more middle-class families every year because of inflation. But because federal lawmakers failed to extend a "patch" that normally protects the less-than-wealthy from the AMT, it is estimated that 16 million more taxpayers could fall into its grasp this year.

The AMT is catching many local taxpayers off guard, according to area financial planners.

Sen. Majority Leader Bill Frist, R-Tennessee, announced in mid-December that legislation targeting the tax would not be completed. The House and Senate passed separate bills applying a temporary fix this year, but the proposals became stuck in a broader debate over tax policy.

Congress for several years has passed temporary fixes that slowed the expansion of the AMT, but those remedies are more expensive each year. The one for 2006 would have cost roughly $30 million. And repealing the tax altogether could cost close to $1 trillion over 10 years, according to the Internal Revenue Service's Taxpayer Advocate, which rates the AMT as the top problem facing taxpayers.

"It was certainly not the intention that it would impact as many people as it has, or has the possibility of ensnaring now," said Bob Bates, a client service provider at locally based Crowe Wealth Management. "On the other hand, it is revenue that the government, with the deficits it's running, would have to come up with somewhere."

The number of AMT filers affected has grown almost 60 percent over the last two years, from fewer than 2.4 million in 2003 to an expected 3.8 million for the 2005 tax year, according to the IRS. The number, however, is expected to balloon to 20.5 million this year.

Federal lawmakers passed the AMT in 1969 after 155 people with incomes above $200,000 used deductions to avoid paying any taxes. The AMT disallows some deductions claimed by affluent filers who itemize.

"At that time, the wealthy people were sheltering very large portions of very large incomes while the rest of us were paying our taxes," said Peter Grossman, a Butler University professor of economics. "So it had some logic at the time, but tax rates have come down, and they have closed a lot of those loopholes."

Because the tax isn't indexed to inflation, it is hitting more families with fairly modest incomes. Moreover, President Bush's tax cuts lowered regular income taxes but not the AMT. If the AMT is higher than the normal income tax, the filer pays the AMT.

Without a retroactive fix, the AMT exemption drops to $45,000 from $58,000 for married couples and to $33,750 from $40,250 for singles. The smaller exemption puts more middle-income Americans at a much greater risk of paying the AMT.

The Tax Policy Center, a non-partisan Washington, D.C., research organization, estimates the percentage of taxpayers earning $75,000 to $100,000 subject to the tax would increase from 1.1 percent to 29.8 percent.

Deductions taken for a home-equity loan, medical expenses or charitable contributions, for example, could trigger the AMT penalty. A family of four earning $80,000 could pay $1,585 more in taxes, according to the nonpartisan Congressional Research Service. Those taxes would be due April 15, 2007.

The AMT rate ranges from 26 percent to 28 percent, while the regular income tax rate tops out at 35 percent. But a family of four earning as little as $58,500 in the 25-percent tax bracket could be subject to the AMT.

"Because of the compression of the tax brackets, it really doesn't take very much for people to get in there," said Rosanne Ammirati, a tax partner at the local accounting firm of Katz Sapper & Miller LLP. "It's pretty much a problem across the board."

Most of her clients are surprised to learn they meet the AMT criteria, she said.

Kevin O'Connell, a principal at the local accounting firm of Somerset CPAs PC, said the AMT isn't normally an issue for filers who earn less than $150,000. He expects that to change, though, if the full AMT exemptions are not restored.

The AMT historically affects Hoosiers less than residents in states with higher income and real estate tax rates. Not even 1 percent of Indiana filers paid the tax in 2003, compared with more than 4 percent who did in New York and New Jersey, according to the IRS.

More than 3 percent of residents in California, Connecticut and Washington, D.C., contributed to the AMT.

Although Congress adjourned without extending the AMT exemption, Grossman at Butler thinks legislators will revisit the matter at another time. The stakes are too high, he said, with Senate and House elections approaching in November.

Grossman, who has a doctorate in economics, said the current tax code is so complex that he doesn't dare attempt to file his own taxes anymore.

"We really need to have a much greater simplification of our taxes," he said. "If we did that, there wouldn't be any reason for the AMT."
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