AMT Yields Unintended Consequences

The big news for millions of taxpayers is Congress's last minute decision to adjust the alternative Minimum Tax. It is a dreaded feature of the tax code that was created decades ago to make sure wealthy people don't deduct their way out of paying taxes.

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RENEE MONTAGNE, host:

The big news for millions of taxpayers this week is Congress's last minute decision to adjust the AMT. The alternative minimum tax is a dreaded feature of the tax code. It was created decades ago to make sure wealthy people don't deduct their way out of paying taxes.

NPR's Anthony Brooks reports on its unintended consequences.

ANTHONY BROOKS: Bryan Hirsch(ph) is a lawyer in Western Virginia. For years, he's been careful to withhold enough taxes so he doesn't have to pay anything come April 15th. In fact, he usually looks forward to a sizable tax refund, and he thought last year was no exception.

Mr. BRYAN HIRSCH (Lawyer): I thought I was doing well. I thought I actually was going to get between $3,000 and $5,000 back. I found out that, in fact, I was owing about $4,000. It was kind of disappointing because you owe money and you're going to be writing a check instead of getting one back.

BROOKS: Like some four million Americans last year, Hirsch was snared by the dreaded AMT, the alternative minimum tax.

Mr. HENRY AARON, (Senior Fellow, Brookings Institution): The AMT is probably the single most reviled feature of personal taxes in the United States.

BROOKS: That's Henry Aaron, a tax expert at the Brookings Institution in Washington. The AMT was set up back in the 1960s to ensure that the very wealthy, who often have lots of deductions, still have to pay taxes. But over the years, more and more middle-income taxpayers have had to pay the AMT and Henry Aaron says there's a reason why.

Mr. AARON: In contrast to the ordinary income tax, the AMT is not adjusted for inflation.

BROOKS: So this week, Congress approved a bill to increase the amount of income that is exempt from the AMT. Without it, the number of Americans subjected to the tax would have risen from four million to 25 million. But Congress stopped short of actually addressing the problem for good; instead they just fixed it for one year. According to Henry Aaron, that's because to fix it for good or to scrap it would mean admitting that long-term projected revenues would go down and the deficit would go up.

Mr. AARON: That's not something any elected official wants to do, so what they've done is a kind of a game. They make an adjustment this year for next year; and then next year, they make an adjustment for the year after.

BROOKS: Still, the plan will spare millions of Americans to tax increase, but it will also delay refunds for some 38 million others - that's because the IRS says it needs time to reprogram its computers and revise the documents affected by the adjustment to the AMT.

Anthony Brooks, NPR News, Boston.

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Q&A: The Alternative Minimum Tax

Calculating tax returns

As Americans calculate what they'll owe come tax time, a growing number of them are finding their bill is bigger than they'd expected — courtesy of the alternative minimum tax, or AMT. iStockphoto hide caption

itoggle caption iStockphoto

Taxes aren't due for another several months, but congressional lawmakers have been busy trying to make sure the 2007 tax season doesn't turn into a major – and expensive – nightmare for those trying to calculate what they owe.

Lawmakers are once again trying to patch a problem with the alternative minimum tax, or AMT, before they adjourn for the year. If Congress doesn't pass a fix soon, the AMT could hit 20 million more taxpayers than it did last year, and millions of others could have their refunds delayed.

While previous fixes to the AMT have spared many taxpayers from paying higher tax bills, it still a term that strikes fear in the heart of many a taxpayer. But just what is it? Here, a primer:

What is the alternative minimum tax?

The alternative minimum tax (AMT) was first enacted in 1969 to make sure that very wealthy people paid at least some income tax. Basically, it's a parallel tax system that is triggered when people with high incomes also claim a lot of deductions.

If the amount an individual owes under the regular tax system is lower than the amount he or she would owe under the parallel AMT system, then the taxpayer must pay the AMT instead. The goal was to make sure that high-income individuals didn't use tax shelters, deductions and loopholes to avoid paying any income tax at all.

Who has to pay the AMT?

Though it started out as a "tax for the rich," the AMT affects more and more taxpayers each year, because the AMT is not indexed to inflation. An income that qualified someone as wealthy in 1969 — say, $100,000 a year — is considered just upper-middle class in 2007, but it could still be enough to trigger the tax.

The AMT often affects individuals with incomes starting around $115,000 a year, and married couples with a joint income of $150,000, says Kate Fries, a financial adviser at the Family Firm in Bethesda, Md. But individuals with lower incomes and various deductions can also be hit.

Under this alternative tax system, taxpayers can't claim deductions for property taxes, state and local taxes, and dependent children. So the AMT has a significant impact on families with children and on taxpayers who have high state and local taxes.

According to estimates from the Tax Policy Center, a Washington, D.C., think tank, if Congress doesn't change the law, 36 percent of married filers with incomes between $75,000 and $100,000 will be hit by the AMT.

How many people does it affect?

The Tax Policy Center estimates that almost 24 million taxpayers will be subject to the AMT for 2007 unless Congress acts to change current law. That's up from the less than 4 million who paid AMT last year, when a temporary, higher exemption was in place.

In 1970, only 20,000 taxpayers were subject to the AMT. If no changes are made, the center estimates that about 39 million taxpayers will have to pay the AMT in 2017.

How can you find out if the AMT will affect you?

Fries suggests that people start thinking about the AMT if they have a yearly income of $100,000 or more. She warns, however, that the AMT can affect taxpayers who earn less than that. And large capital gains — from, say, selling stocks at a profit — can also push an individual into the AMT for a year, even if his or her average yearly income does not.

Calculating whether you'll have to pay AMT can be notoriously complicated. Fries notes that most computer tax programs will run these calculations for you, as will a CPA. But, she says, nobody should try to figure out if they owe AMT using pen and paper forms.

Taxpayers in high-tax states – such as New Jersey, New York, Connecticut, California and the District of Columbia — are more likely to owe AMT than others.

What should you do if AMT does apply to you, or if you think it might?

There's really not much you can do about it, according to Fries. But if you know you'll have a large capital gain, or some other unusual financial circumstance, consult an accountant early.

Another way to lower AMT is to reduce income, by making charitable contributions or by contributing more to a 401(k) or individual retirement account.

Will there be another patch next year?

Passing the AMT patch has become routine for congressional lawmakers, who for years have said that a more permanent fix to the system is also needed. The biggest obstacle to reform is the price tag: repealing the AMT would cost the federal government about $1.7 trillion in lost revenues.

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