A Congressional Research Service (CRS) Report entitled “The Alternative Minimum Tax for Individuals” responds to rising concern over the alternative minimum tax (AMT). In particular, it examines the combined effects of not having inflation-adjusted AMT exemption amounts and the pending expiration of the regular income tax cuts under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA, P.L. 108-27) (i.e, the 2001 and 2003 income tax cuts).
Observation: The AMT is only one of the many seemingly intractable problems that Congress will have to consider in the near future, including the EGTRRA sunset of the individual tax rates and close to fifty other “extender” tax provisions that have or are about to expire. A quick fix for the looming AMT problem would be yet another temporary AMT “patch.”
Background. The AMT is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%.
For 2012, the individual AMT exemption amounts fall to the “permanent” AMT exemption amounts in Code Sec. 55(d)(1)—unless Congress retroactively changes them—$33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for marrieds filing separately. The 2001 and 2003 tax cuts provided temporary increases in the AMT exemption amounts as a means of mitigating the interaction between the reductions in the regular income tax and the AMT. These amounts have since been “temporarily” extended and increased over the years by a succession of tax laws. The latest, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act, P.L. 111-312, 12/17/2010), extended higher AMT exemptions amounts for two years (in a so called two-year AMT “patch”).
As an example of the higher exemption amounts, the 2011 exemption amounts were as follows:
- Married individuals filing jointly and surviving spouses: $74,450, less 25% of AMTI exceeding $150,000 (zero exemption when AMTI was $447,800); (Code Sec. 55(d)(1)(A)
- Unmarried individuals: $48,450, less 25% of AMTI exceeding $112,500 (zero exemption when AMTI was $306,300); (Code Sec. 55(d)(1)(B)) and
- Married individuals filing separately: $37,225, less 25% of AMTI exceeding $75,000 (zero exemption when AMTI was $223,900). But AMTI was increased by the lesser of $36,225 or 25% of the excess of AMTI (without the exemption reduction) over $223,900. (Code Sec. 55(d)(1)(C))
Observation: The AMT exemption amount for married individuals filing separately is 50% of the AMT exemption amount for joint filers and surviving spouses. Thus, for 2011, the AMT exemption amount for married individuals filing separately was increased to $37,225 (50% of $74,450).
Similarly, the ability of individuals to use most nonrefundable personal credits to offset AMT has also been temporarily extended over the years by a series of tax laws so that individuals have been able to use most nonrefundable personal credits to offset AMT. Thus, for example, for tax years beginning during 2011, an individual could offset his entire regular tax liability and AMT liability by the nonrefundable personal credits. (Code Sec. 26(a)(2))
Observation: The rule allowing nonrefundable personal credits to reduce the AMT (as well as regular tax) benefits middle income individuals who: (a) have low taxable income (and thus a low regular tax), e.g., because of a large number of personal exemptions; (b) are subject to the AMT because personal exemptions (as well as the standard deduction and certain itemized deductions) generally aren’t allowed in computing the AMT; and (c) have substantial nonrefundable personal credits.
Unless there’s a law change, for tax years beginning after 2011, nonrefundable personal credits—other than the adoption credit, the child credit, the savers’ credit, the residential energy efficient property credit, the non-depreciable property portions of the alternative motor vehicle credit, the qualified plug-in electric vehicle credit, and the new qualified plug-in electric drive motor vehicle credit—will be allowed only to the extent that the individual’s regular income tax liability exceeds his tentative minimum tax, determined without regard to the minimum tax foreign tax credit. For tax years beginning after 2012, the child tax credit and the adoption credit also will be subject to the above general limitation.
CRS’s analysis. The CRS Report notes that unless Congress acts, the combined effects of inflation and the reductions in the regular income tax will cause an estimated 30 million plus taxpayers, or roughly one-fifth of all taxpayers, to be hit by the AMT in 2012. Under the regular income tax, the tax rate structure, the standard deductions, the personal exemptions, and certain other structural components are indexed so that they do not lose their real (inflation-adjusted) value over time. However, the structural components of the AMT are not indexed for inflation.
The lack of indexing means that over time, real AMT tax liabilities will increase because of inflation. The gap between tax liabilities under the regular income tax and the AMT will shrink, and many taxpayers could end up subject to the unindexed AMT or experience reductions in their nonrefundable tax credits under the regular income tax.
This problem has long been recognized. In ’97, approximately 605,000 taxpayers or about 1% of all taxpayers were subject to the AMT. In 2009, 3.8 million or about 2.7% of all taxpayers were subject to the AMT. Estimates indicate that in 2012 (when the latest AMT patch expires), over 30 million taxpayers will either fall under the AMT or have AMT limits on their tax credits under the regular income tax. If there is no patch for the AMT, then by 2020, 58 million taxpayers will be affected by the AMT.
Any future reductions in the federal income tax burden without accompanying modifications to the AMT would likely increase the number of taxpayers subject to the AMT. Despite the individual income tax rate reductions and the marriage penalty tax relief provisions of the 2001 and 2003 tax cuts, many taxpayers in the middle income ranges will find that when they file their 2012 returns, the AMT will “take back” much of the tax benefit contained in the tax cuts.
It might be suggested that the regular income tax should be reformed so as to bring it more in line with an economically ideal income tax (ending any number of special tax preferences). Then, the AMT could be eliminated. However, the CRS Report concludes that it is unlikely that the tax base of the regular individual income tax will be broadened to the point where there was no place for an AMT.
CRS’s conclusion. The CRS Report concludes that Congress should consider modifying the tax system if it wants to: (1) retain the social and economic incentives in the Code while maintaining the concept that everyone should pay at least a minimum level of income tax; and (2) limit the number of taxpayers subject to the AMT. Modification would involve two primary issues: inflation and AMT coverage.
Indexing the structural components of the AMT for inflation—perhaps the most important change that could be made—would allow a consistent separation of the two tax systems (the regular income tax and the AMT) to be maintained over time and would result in substantially reducing the number of taxpayers projected to be affected by the AMT in the future. This was one of the proposals in the President’s FY2013 budget.
The second issue concerns the coverage of the AMT. Originally, the AMT was intended to cover only high-income taxpayers. However, changes to the Code since the AMT was first introduced (primarily the 15% maximum tax rate on dividends and long-term capital gains income under both the regular income tax and AMT) have markedly increased the availability of special tax preferences to taxpayers in the middle and upper-middle range of the income distribution. The CRS Report notes that this is likely to produce large deviations in the income tax liabilities of otherwise similarly situated taxpayers in these income ranges.
The cost. Any permanent fix to the AMT would be expensive. The CRS Report notes that there are several tax reform proposals to deal with the AMT problem, including the repeal of the AMT. But, if the AMT were repealed without adjustments to the regular income tax, the lost revenue would be significant—over $1.3 trillion between 2011 and 2022 if the 2001 and 2003 tax cuts were not extended, and over $2.7 trillion if they were extended.
Indexing the AMT exemption amounts for inflation at the 2009 levels through 2020 (assuming the 2001 and 2003 tax cuts were extended) would cost an estimated $1.2 trillion. The cost of the last two-year AMT patch (for 2010 and 2011) under the 2010 Tax Relief Act was estimated at $136.7 billion. Indexing the AMT for inflation permanently, as proposed in the President’s FY2013 budget, would cost an estimated $1.9 trillion over the 2013 to 2022 budget window. In the Senate, S. 3521 would patch the AMT for the 2012 and 2013 tax years for an estimated revenue loss of $132.2 billion.
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