Taxation systems and economic impacts

Accounting - Alternative Minimum Tax

ALTERNATIVE MINIMUM TAX

The Alternative Minimum Tax Concept:

When originally enacted in 1970, the purpose of the Alternative Minimum Tax (AMT) was to redress the specific situation that had permitted some of the wealthiest families in the nation to avoid nearly all tax liability (Leiserson 2008). By exploiting existing loopholes in the pre-AMT Tax Code, the wealthy had qualified for so many deductions that some of them paid no income taxes at all. Generally, the AMT rate applies to individual taxpayers and households with income above roughly $150,000 and below approximately $400,000 (Leiserson 2008).

Since 1986, the tax reforms passed by the Reagan administration significantly changed many elements of the liability criteria for the AMT, resulting in its application to an entirely, much larger, different segment of taxpayers than intended by its original design (NYT 2007). Specifically, the Tax Code now prohibits many types of so-called tax preference item exemptions previously allowed for upper-middle-class taxpayers, such as long-term capital gains, various types of formerly tax-exempt income, depreciations, personal exemptions, particular kinds of medical expenses, and even the standard deduction (NYT 2007).

The income tax liability of taxpayers affected by the AMT is generally between 26% and 28% and among taxpayers with similar incomes, is more likely to apply to those owning residences in high-tax states as well as those with minor dependents. It applies in much the same way as a flat tax on taxpayers earning more than $175,000 of which a slightly lower rate applies to the first $175,000 (CBO 2004).

Furthermore, the complexities of the AMT require taxpayers who are potentially subject to it to calculate their potential AMT liability in advance to avoid subsequent penalties triggered by their failure to do so until directed by IRS after filing (CBO 2004). Potentials Benefits:

The benefit of the AMT was that it corrected the inequities associated with the ability of the wealthy to minimize their tax obligation while much less wealthy taxpayers absorbed a disproportionate burden of supporting federal expenditures funded by income tax.

Some of the loopholes in the pre-AMT Tax Code had evolved into windfall tax shelters used by many extremely wealthy taxpayers to structure their income and assets so as to avoid virtually all income tax liability (NYT 2007).

In principle, the concept was sound, at least until the Tax Reform Act of 1986 dramatically expanded its application to the detriment of many more taxpayers whose income is nowhere near the threshold of actual wealth to which it was originally applicable exclusively. Naturally, to the extent the AMT applies to the specific segment of taxpayers to whom it was initially addressed, it is serves a beneficial purpose; on the other hand, that benefit must be considered against the unintended consequences and unfairness of its application to taxpayers completely outside the ranks of the very wealthy, particularly at the lower end of that income category. Undesirable Consequences:

The first major potential problem with the AMT is that it does not incorporate inflation at all; as a result, it applies to more and more taxpayers every year despite the fact that their wealth actually remains unchanged during that time. This is particularly important in times of economic recession, especially where income increases fail to keep pace with rising inflation. Whereas the AMT applied to a fewer than 200 households when first implemented in 1970, it currently affects as many as 15% of households earning as little as $75,000 annually (Leiserson 2008).

Because the AMT criteria calculate capital gains on an annual basis instead of a multiple-year basis, it effectively prohibits any deductions associated with losses carried forward from previous years. Similarly, it penalizes taxpayers whose annual earnings fall steadily between the lowest threshold and the cutoff of approximately $400,000, while exempting AMT liability for those earning the same over a multiple-year period. More importantly, it does not apply to some taxpayers who are much closer in actual wealth to the very taxpayers whose tax liability restructuring generated the need for the AMT in the first place: specifically, the truly wealthy who earn many times the $400,000 cutoff.