AMT (Alternative Minimum Tax)
AMT was created back in the 1970’s and then with serious teeth in the 1986 tax reform act which was to simplify taxes. AMT is a political system that renders certain tax deductions useless like state income and property taxes. AMT was actually created and refined when Republicans held the legislative and executive branches and is seen by many as a way to equalize the field for taxpayers in high state income taxes like CA vs taxpayers in low tax jurisdictions like AZ or no tax jurisdictions like NV, WA, FA, and TX.
Understanding AMT and tax preferences
Before AMT, taxpayers could deduct state, property taxes, and use accelerated depreciation to lower their current tax rate by 1) Prepaying these taxes 2) Purchasing certain depreciable property and reducing income with accelerated depreciation (mainly in real estate) 3) Having many dependents (large families) 4) Holders of incentive stock options
Another way to characterize AMT is that it is a floor tax that mitigates the deductibility of certain tax expenditures that have political overtones. AMT taxes AMT income at 28% (basically a compromise rate between 20% and 36% ,the top tax rate in the mid 80’s. (it used to be 26%). Keep in mind the top tax rate has now increase to 39.6%, so I would expect a commensurate increase in AMT rate to 30% but more people an entrapped by AMT now and thus the political costs are higher. AMT collections in 2008 were $70 BN, a large sum to replace if repealed. Interesting fact is that if the regular tax system was repealed the cost of that is $63 BN. This means that AMT now makes up over half of individual income tax collections and I don’t think that was the intention of its creators nor the current political class today.
For example, high income tax states like CA actually get an incentive to increase their tax rates on higher income individuals at the expense of the federal government since these state taxes are deductible. This so-called state income tax preference soaks the high income taxpayer in those states at the expense of the federal government. Needless to say, the federal government was not too happy about subsidizing these states and the Republicans in their haste for tax simplification and tax trading with Democrats backed this system.
Other tax preferences were also used in AMT. AMT shortened the benefits of accelerated depreciation or even straight line depreciation of certain tangible property by increasing those lives or instead of using 200% accelerated depreciation, it became 150%. There even became a third level of depreciation in ACE depreciation that affected only C corporations. Politicians viewed AMT as a necessary evil to get certain tax rate deductions mainly on capital gains taxes (decreased from as high as 36% to 15 and now 20%) for certain high earners. This particular aspect of AMT affected real estate owners and focused on higher value properties that have more at stake for AMT.
Another aspect of AMT is the addback of dependency exemptions. This part of AMT affects larger families or household members that support multiple parents or siblings. I can’t think of the political ramifications other than to have smaller families or support less dependents. The growth of earned income tax credit seems to be the trade-off with this tax preference item but that particular credit only affects the truly impoverished at less than $30,000 of income. The aspect of AMT hits those making $150,000 and above, thus penalizing higher middle class families that support dependents.
Lastly a little noticed AMT preference is the incentive stock option exercise. This exercise allows for the holders of these options (usually employees of tech startups) to enjoy the fruits of owning company stock at bargain prices without paying any withholding taxes. AMT again renders this advantage useless because the bargain elment is not an AMT preference.
In conclusion, the AMT tax is a tax that affects taxpayers in high state tax jurisdictions, real estate owners, middle class earners with large families, and high tech / growth oriented business owner/employees. Also it makes a shambles of our tax code in that another system of taxation exists that very few people understand and the error rates on it can be dramatic. Because of these reasons, the AICPA and other non partisan groups have advocated for its repeal. The other element to consider is the cost of repeal is too high as it costs over $70BN now and in a 10 year period that is $1 TN, which is still a huge number.