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“Everyone wants to live at the expense of the state. They forget that the state wants to live at the expense of everyone.”     Frederick Bastiat

February 20, 2006

Who Benefits Most From AMT Reform?

by Brad Warbiany

In the news recently, and in Congress, discussion has focused upon how the AMT’s net is widening, and the looming “crisis” when it spreads. There’s expected to be an enormous (4x or more) increase in the numbers of taxpayers subject to the AMT in the next year, and the ramifications of this will be brutal if nothing is done. How brutal? Instead of the current 3-4% of households subject to the AMT, we’ll be looking at about 15%:

This parallel tax system was created two generations ago to take away tax breaks from about 150 wealthy taxpayers who had piled up write-offs to erase their tax bills. Chances are, it seems irrelevant if you aren’t among the 4 million taxpayers who owe it for 2005.

But give it time – a year, to be exact. These days you don’t have to be rich for the AMT to wipe out your write-offs.

Though most of them are unaware of it, 21 million Americans are on the hook to pay the AMT next tax season barring intervention from Congress. Some experts predict lawmakers will restore an expired tax provision that had slowed the AMT’s spread through 2005. If they don’t, however, it will unleash a fivefold increase in the number of taxpayers who will owe what one prominent U.S. senator calls the “Darth Vader of the tax code.”

The AMT will strike 35 percent of all taxpayers with $50,000 to $100,000 of adjusted gross income in 2006 – up from 1 percent in 2005, according to the CBO. Two out of three will owe it in 2010.

The AMT will hit 81 percent of taxpayers with $100,000 to $200,000 of adjusted income in 2006, nearly five times the 17 percent share in 2005. It will net more than 95 percent in 2010.

To understand the problem, a little bit of history is in order. The AMT was started in 1969 after it was found that a few very wealthy Americans managed to completely evade paying income taxes. The idea behind the AMT is a brute-force solution to a complex tax code, telling individuals that despite the fact that lawmakers have written thousands of deductions, exemptions, and special rules into the tax code, there is a certain minimum that must be paid. Rather than fix the root problem, which is the carving out of deductions and rules to please special interests, they said that all those rules apply, but only to a certain point.

All the AMT was designed to do is to reduce the impact of all the loopholes and deductions in the tax code, and ensure that those with the means to direct their assets to reduce their taxable income still pay “their fair share”. I personally believe that if we want to look at the problems correctly, we should solve the source (special interest loopholes and deductions), but I’m also an engineer. I know as well as anyone that at times, solving the root problem is simply too difficult. I’ve worked with customers who are running into a technical problem, and it is simply more effective, less costly, and quicker to brute-force a solution than to go fix to the root cause. Given that fixing Congress is probably not going to happen any time soon, the AMT is good legislation– in theory.

In theory, Congress is trying to blunt the tax implications of a few very rich people who are able to shuffle assets and income to reduce tax liability. It is designed for those people who have much more economic freedom than the “average” taxpayer. But therein lies the problem. Congress didn’t design this legislation well, and it’s increasingly affecting the “average” taxpayer (quotes added as it is still restricted to the upper-income taxpayers, but increasingly affecting people who do not employ the sort of advanced tax strategies this legislation was targeting).

It’s somewhat likely that I will be feeling the effect of the AMT next spring, and I can tell you I’m not happy about that. I, like many other people, have to plan my finances based upon certain information. One aspect of that information is the level of mortgage interest I pay, which is deductable. Given that I’ve only owned this home for a year, I’m still at a point where the bulk of my monthly payments are interest, and thus get a fairly substantial deduction. I don’t yet have kids, so perhaps I may be spared. I know lots of young professionals with kids, though, living in places like California or the Northeast, who will run into the AMT next year because their deductions are just “too large”. Especially with the larger mortgages they carry, the interest deduction and exemptions for kids will quickly put them in the AMT’s clutches. For people like me, who base certain financial decisions on what we know of the tax code, getting snared in the AMT net could be tremendously painful.

Congress have their backs against a wall. Budget and revenue projections depend upon the income of the AMT to continue as if there is no reform. Our legislators are expecting to spend the money raised by ensnaring millions of people in this net. When the President’s tax panel gave their recommendations, the reason they had to cut so many personal deductions was to offset the cost of fixing the AMT. They know that to fix the AMT will be incredibly painful, because they either have to reduce their spending plans (not likely!) or find revenue elsewhere– raising other taxes or eliminating deductions.

Congress does not want to fix the AMT. In fact, given that Congress really doesn’t care very much about the “average” taxpayer– as evidenced by their spending habits rewarding people who contribute to campaigns and screwing the rest of us– I don’t think they even care about the financial implications of the AMT upon us. After all, what we earn is legitimately the government’s money, and we should all be grateful they let us keep so much of it. They do care, however, about the political implications. If the AMT ensnares 21 million people this year, the backlash will be enormous. While Congresspeople don’t regularly pay attention to the worries and concerns of us plebes, they saw after Kelo that we can be a sleeping giant. They know that 21 million people feeling the pinch of the AMT may result in them losing their seat of power, which is their greatest and only fear.

Congress is starting to realize that they must reform the AMT or they’ll be in serious political jeopardy. For those of us who pay taxes, however, we know they’re not going to cut spending, so they’ll find another place to squeeze money from us. They’ll distribute the pain the AMT would have caused, in small changes to deductions and exemptions that cause just as much pain for taxpayers, but are harder to spot. We’ll still be screwed, but they’ll be safe. And then they’ll trumpet how wonderful they are for saving 21 million Americans from the AMT, when all they’ve done is to hide that taxation elsewhere.

So who benefits the most from reforming the AMT? Congress. Not that anyone should be surprised by this, of course. The only reason Congress does most things is to increase their own power, and shore up their own safety in office, as we saw from the Bipartisan Incumbent Protection Act of 2002. Remember who’s running this shell game, and you’ll realize that despite how close you’re watching, the shell you pick will be empty.

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4 Comments

  1. Already been hit. Ever heard of indexing? Stupid Congress.

    Comment by Upper Middle Class Man — February 20, 2006 @ 2:35 pm
  2. I’ll be hit next year thanks to my recent California home purchase. Awesome!

    Comment by Bret — February 20, 2006 @ 5:27 pm
  3. I’m fairly sure I get hit next year too.

    Comment by Eric — February 20, 2006 @ 5:31 pm
  4. Personally, I’m one of those folks that may not worry too much about whether or not this happens next year. It’s getting to the point with this tax code that I’d rather see the people of this country get enraged than see another piecemeal attempt at “fixing” the problem. As I said, their “fix” will simply be to spread the pain around slightly and hide it in other taxes or loopholes.

    Comment by Brad Warbiany — February 20, 2006 @ 5:42 pm

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