Both houses of the Republican-controlled Congress passed sweeping tax reform legislation on December 20. Despite the GOP’s longstanding push to repeal of the alternative minimum tax (AMT), it remains in the tax code, albeit in a tamer form. By backing off its repeal efforts yet again, Congress missed an opportunity to restore some transparency to the tax code.
Given the aura of elitism surrounding the original GOP tax reform measures, many observers assume that repealing or reducing the power of the AMT only benefits the privileged. Critics of the measure are right to consider it a tax on the rich, but its story is more complicated than that. Since its enactment, it has engulfed more and more taxpayers while most of the richest Americans remain unscathed.
In 1969, Congress passed the alternative minimum tax in an attempt to target 155 wealthy individuals who were able to take advantage of so many deductions, credits, and other loopholes in the tax code that they did not pay any income tax whatsoever. On its face, this seemed like a fair policy––it resembled a safety net of revenue to ensure everyone contributed their fair share to the federal coffers. But most of the particular loopholes that the tax was designed to patch have since been repealed. Yet, the AMT remains in the tax code, affecting four million households.
True to its name, the AMT functions more or less as a separate income tax. Taxpayers calculate liability under the primary tax code first, taking advantage of any deductions or credits for which they qualify. If their annual incomes are above a certain threshold ($54,300 for individuals in 2017 and $84,500 for joint filers), then they must file their taxes again, this time under lengthier and more stringent parameters. A taxpayer pays the AMT when the formula decides she qualifies for too large a tax return and effectively pushes up her tax bill in response.
Despite politicians’ original intent, very few actual AMT taxpayers are lawyered-up fat cats scraping the tax code for any and all loopholes. In fact, most of the deductions the AMT catches people “abusing” apply to almost all taxpayers. The majority of AMT taxpayers qualify due to their state and local tax deduction. Because the tax disallows the state and local tax deduction, residents of high-tax states are more likely to pay it. About a fifth of ensnared taxpayers qualify due to personal exemptions. Married couples and sizable families are more likely to be liable. Various business-related deductions account for about a tenth of AMT taxpayers. Property tax deductions and some itemized deductions can also help trigger liability.
These parameters cast a wide net, catching many households the tax was never intended to affect. A tax intended to pull revenue from the 155 riches tax evaders in our country now raises taxes for upwards of 5 million taxpayers. In a 2012 letter, Acting Commissioner of the IRS Steven Miller expressed fear that 30 million taxpayers could eventually face the AMT.
Furthermore, the wealthiest Americans are actually less likely to pay the AMT than middle- and upper-middle income households. The high top marginal tax rate (39.6 percent this year) tends to set taxable income too high for the threshold to match. In 2013, more than three out of four households with incomes over $10 million avoided paying the so-called safety net of taxes. Less than a fifth of incomes between $1 and $10 million paid the tax. Considering thousands of the country’s highest earnings remain untaxed, it is no wonder that some dissenters say the tax hits the “wrong” people.
The AMT raises tax bills for those who fall under its umbrella, but it presents further costs by adding another layer of complexity to an already-Byzantine tax code. Adding as many as 80 lines of additional code to file, the AMT can increase both the time and financial costs of tax compliance. Those who previously preferred to file their taxes on their own will likely need professional help. A 2001 Joint Economic Committee report estimated that AMT compliance costs were equivalent to nine percent of the revenue it generated, five times higher than the standard income tax, which had compliance costs equal to 1.6 percent of the revenue it generated. Tax complexity also hits taxpayers with time costs. No one would voluntarily choose to file their taxes twice; we prefer to work, enjoy time with family and friends, or enjoy a hobby. This tax makes Americans less productive and less happy.
Because the tax code is so arcane, many middle-class Americans are ignorant about their liability status and accidentally violate tax code. Households above the income threshold who do not file under the alternative minimum tax are subject to interest and possibly penalties. A married couple making $45,000 each may, understandably, not expect a need to file for a tax thought to affect rich people. If they fail to file under AMT rules, however, they could ultimately owe back taxes, interest, or even penalty fees from the IRS. Details of penalty costs are not prevalent, but IRS National Taxpayer Advocate Nina Olson estimated that 176,000 qualifying households owed the IRS $103 million in tax penalties in 2001. The very presence of the AMT makes tax day more costly even for families who don’t have to pay it.
Although it is responsible for about $38 billion in tax revenue, eliminating the AMT does not necessarily mean Congress loses that tax base. Those taxpayers will simply be liable for the standard income tax. The federal tax code would no longer penalize Americans based on their geography, family composition, or knowledge of a 10 million word tax code.
Congress and its critics would do well to see the consequences of policies, not just their intentions. Maintaining political appearance means little to the middle-class families the AMT will blindside next year.
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