Are your income tax returns finished yet?
Did you check out line 45 on the second page of your 1040? That’s where you look to see if you had to pay an extra amount of tax called the Alternative Minimum Tax (AMT).
Usually, when people see they’ve been required to add this mysterious little item onto their already high-enough income taxes, they are pretty perplexed. They feel like they’re being punished and they’re often not sure why.
So what is the Alternative Minimum Tax (AMT) anyway? It is a completely separate system of income taxes that exists in addition to the regular tax system. To find out whether it is owed, taxpayers have to calculate their regular taxes under the usual set of rules, and then calculate their AMT by using a different set of rules.
The AMT rules tax certain income items that are tax-free under the regular system, and they take away certain deductions that are allowed under the regular system.
The trade-off is that there is a relatively large income exemption amount, below which no AMT will apply.
The AMT system has been in place since 1969, when Congress learned that there were 155 taxpayers who had high incomes, but who had used legal deductions and tax benefits to reduce their income taxes to zero. Congress created this alternative system in an effort to stop such apparent unfairness and ensure that every taxpayer with significant income would pay at least some taxes.
The AMT today
The problem is that since 1969, the application of the AMT has reached far beyond the aberrant cases it was established to catch.
More than 4 million taxpayers paid AMT with their 2006 returns. And it no longer applies principally to very wealthy taxpayers who claim obscure or extreme tax benefits. It now applies to many taxpayers with only modestly high incomes who are claiming routine deductions.
For instance, state and local income taxes are deductible for regular income taxes, but they must be added back for AMT. The $3,400 deduction that is allowed as a personal exemption for each member of the family on the regular tax return must be added back for AMT.
Middle-class implications
The result is that taxpayers with large families or those who live in places with high state and local income taxes are more likely to have to pay additional taxes under AMT. There are many more examples of ordinary taxpayers getting caught by the AMT every year.
AMT’s reach has grown mainly because the AMT provisions are not indexed for inflation. In the regular tax system, tax brackets and many other measures are indexed each year based on the consumer price index. This protects taxpayers from paying higher and higher taxes every year simply because of inflation-related raises in pay and other income.
However, AMT rates and exemption amounts are not tied to inflation. The result is that a taxpayer’s AMT might get higher each year while his regular tax stays about the same.
How it applies
Of course, the complexity of maintaining two separate systems of income taxes might be more distressing than having to pay the actual tax itself.
To find out if AMT applies, a taxpayer must first calculate his income tax under the regular system, and then separately compute his AMT under the different rules.
For many people, the regular system already can be fairly complicated. The AMT then is calculated on IRS Form 6251, which is 55 lines long and is supported by 10 pages of sometimes mind-boggling and convoluted instructions.
Many schedules in the regular tax return also have to be redone for AMT purposes.
Most tax professionals agree that the current dual system of income taxes should be simplified and made more equitable.
Congress tends to fix impending disasters caused by the AMT one or two years at a time, as it did in December in approving a one-year increase in the AMT exemption amounts scheduled to drop drastically after the expiration of the 2006 fix.
Some people argue that one or the other of our two systems should be abolished altogether.
Under the regular tax system, limits are already placed on high income taxpayers’ use of many tax benefits. Calculating taxes under two sets of laws is a cumbersome process that is causing an increasing outcry from both taxpayers and tax professionals.
