The Individual Alternative Minimum Tax

1
The Individual Alternative Minimum
Tax Presidents Advisory Panel on Federal Tax
Reform 3 March 2005 Leonard E. Burman Senior
Fellow, The Urban Institute Codirector, The Tax
Policy Center Visiting Professor, Georgetown
Public Policy Institute
2
Background

• 1966 155 high-income taxpayers paid no income
  tax
• 1969 creation of a minimum tax designed to
  ensure high income filers did not exploit tax
  laws to reduce or eliminate their federal income
  tax liability
• 2010 AMT will affect 30 million taxpayers,
  including virtually all upper middle class
  families with two or more kids.

3
Determination of AMT Liability

• Add preferences and adjustments to taxable income
• Subtract AMT exemption
• Calculate tax using AMT rate schedule and rules
• If more than regular tax, pay the difference as
  AMT
• (Many complexities left out of this simplified
  explanation.)

4
AMT Exemptions and Schedule

• AMT exemption currently 58,000 for couples,
  40,250 for singles
• In 2006, exemption drops to 45,000/33,750
• Exemption phases out at higher incomes, creating
  high implicit tax rates
• Statutory rates 26 and 28, but exemption
  phaseout creates phantom rates of 32.5 and 35
• Not indexed for inflation

5
AMT Preference Items

• State and local tax deductions (51 of total)
• Personal Exemptions (22)
• Miscellaneous deductions above the 2 floor (20)
• Net Operating Losses (12)
• Incentive Stock Options (2)
• Passive Activity Loss (2)
• Post-1986 Depreciation (1)
• Standard Deduction (1)
• Private Activity Bonds Interest (1)
• Medical Deductions (1)
• Note Sum adds to more than 100 percent because
  some adjustments not shown, such as state tax
  refunds, are negative.
• Source Burman and Weiner, Suppose they Took
  the AM out of the AMT.

6
Causes of AMT Growth
Current Law (extended)
Effect of income tax cuts without permanent AMT
fix
Pre-2001 Law
Effect of failure to index for inflation
Pre-2001 Law, with indexing
Urban-Brookings Tax Policy Center Microsimulation
Model, 2005
7
AMT Projections

• Baseline AMT revenue 1.2 trillion from 2005-15
• 670 billion if the tax cuts are not extended in
  2010
• About 4 of taxpayers on AMT in 2005
• 20 in 06 and 30 in 10

8
AMT Demographics (2010)

• AMT inflicts large marriage/child penalties
• 48 of married couples vs. 3 of singles on AMT
• 94 of marrieds with 2 kids and AGI between
  75100K
• Residents of high-tax states are 5 percentage
  points more likely to be on AMT than those in
  low-tax states

9
Drifting Off Target

• Though intended to make high-income people pay
  tax, AMT will increasingly hit middle class
• Over 80 of AMT taxpayers will have income lt
  200K in 2010
• More than 1/3 have income lt 100K
• Families earning 75-100K 18 more likely to be
  on AMT than those earning over 1 million
• Those earning 100-200K more than twice as likely
  as millionaires

10
Problems with the AMT

• Good Tax Policy is
• Simple
• Efficient
• Fair
• The AMT violates all of these principles.

11
Pointless Complexity

• Many middle class taxpayers must file AMT Form
  6251, but owe no AMT
• AMT rules regarding credits, capital gains,
  dividends, deferral preferences very complex
• Most deferral preferences dont even generate
  much revenue, just change the timing of tax
  payments
• Vastly complicates tax planning

12
Efficiency

• The AMT raises marginal tax rates for most
• 71 of AMT taxpayers face higher marginal tax
  rates under AMT in 2005
• 92 will be in that situation in 2010
• People creep into higher brackets over time
  because, unlike the regular income tax, AMT is
  not indexed
• Might enhance efficiency to extent that it
  deterred tax shelters, but 90 of AMT preferences
  have nothing to do with shelters

13
Equity

• Nasty marriage/child penalties
• Some legitimate adjustments to ability to pay are
  disallowed under AMT (e.g., contingent legal
  fees)
• AMT makes the tax system more progressive, but
  less so over time
• Relatively little tax collected from very rich

14
Conclusions

• Pointless complexity and bizarre pattern of taxes
• Increasingly a tax on the upper middle class
• Better to build anti-tax shelter provisions into
  regular tax and adjust rates to hit revenue target

15
Appendix

• Supplemental tables and charts
• Further reading

16
AMT Exemptions and Schedule
17
Rate Schedule for Couples, AMT vs. Regular Tax
2004
18
Total AMT Revenue, 2005-15
Current Law (extended)
Pre-EGTRRA Law
Urban-Brookings Tax Policy Center Microsimulation
Model, 2005
19
By 2008, it will cost more to repeal the AMT
than the regular income tax.
Cost of repealing the regular tax
Cost of repealing the AMT
Urban-Brookings Tax Policy Center Microsimulation
Model, 2005
20
AMT Projections by Individual Characteristics
Percent on AMT
Current Law
2005
2006
2010
Characteristic
Percent of Taxpayers
3.8
20.4
30.4
Percent of Tax Filers
2.7
14.6
22.6
by Filing Status
Single
0.8
1.6
2.9
Married Filing Joint
5.2
30.7
47.9
Head of Household
0.8
4.2
7.9
Married Filing Separate
5.9
29.0
45.9
Addendum AMT Revenue in billions, 2005-2015
Current Law Current Law Extended
Urban-Brookings Tax Policy Center Microsimulation
Model, 2005
21
AMT Projections by Individual Characteristics
AMT Participation Rate (percent)
Current Law
Characteristic
2005
2006
2010
Filers By State Tax Level
Low
0.8
10.5
18.3
Middle
1.3
13.9
22.6
High
2.7
15.8
23.8
Filers by Number of Children
1.8
8.3
15.6
0
2.5
17.6
27.9
1
5.0
31.4
40.6
2
8.4
37.0
47.7
3 or more
Married Couple, 2 kids, 75kltAGIlt100k
1.6
77.2
94.4

• Excludes effect of sales tax deduction, in
  effect for 2005.
• Urban-Brookings Tax Policy Center Microsimulation
  Model, 2005

22
AMT Projections by Income
AMT Participation Rate (percent)
Cash Income (thousands of 2003)
Current Law
2005
2006
2010
Less than 30
0.0
0.0
0.0
30-50
0.1
1.1
2.9
50-75
6.0
16.9
0.5
75-100
0.8
31.8
53.4
6.8
100-200
63.0
81.0
53.4
200-500
87.0
93.9
39.3
500-1,000
51.8
62.6
1,000 and more
26.7
33.4
35.3
Urban-Brookings Tax Policy Center Microsimulation
Model, 2005
23
Percent of AMT Taxpayers who Face Higher Marginal
Tax Rates Under the AMT
Source Urban-Brookings Tax Policy Center
Microsimulation Model, 2005
24
Distribution of AMT versus Regular Tax Liability
2005 2010
25
Further Reading

• Burman, Leonard E. and David Weiner. 2004.
  Suppose They Took the AM out of the AMT?
  available at www.taxpolicycenter.org. (examines
  issues raised if the AMT were a standalone income
  tax)
• Burman, Leonard E., William G. Gale, Jeffrey
  Rohaly, Matthew Hall, and Mohammed Adeel Saleem.
  2004. AMT A Data Update available at
  www.taxpolicycenter.org. (includes estimates of
  some reform options)
•  
• Burman, Leonard E., William G. Gale and Jeffrey
  Rohaly. 2003. Policy Watch The Expanding Reach
  of the Individual Alternative Minimum Tax, with
  Journal of Economic Perspectives 17(2) 173-186.
•  
• Burman, Leonard E., William G. Gale, Jeffrey
  Rohaly, and Benjamin H. Harris. 2002. The
  Individual AMT Problems and Potential
  Solutions, National Tax Journal 55(3) 555-596.
•  
• Feenberg, Daniel R., and James M. Poterba. 2004.
  The Alternative Minimum Tax and Effective
  Marginal Tax Rates, National Tax Journal 57(2)
  407-427.
• General Accounting Office. 2000. Alternative
  Minimum Tax An Overview of its Rationale and
  Impact on Individual Taxpayers. Report to the
  Chairman, Committee on Finance, U.S. Senate
  (GAO/GGD-00-180). August.
•  
• Harvey, Robert P. and Jerry Tempalski. 1997. The
  Individual AMT Why it Matters. National Tax
  Journal 50(3) 453-473.
•  
• Rebelein, Robert and Jerry Tempalski. 2000. Who
  Pays the Individual AMT? U.S. Department of the
  Treasury, OTA Paper 87.  
•  
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