Link to special CCH Tax Briefings on key topics from 2003:
 

• Year-End Tax Legislation Update (Dec. 10)
• Corporate Income Tax and 'Bonus' Depreciation
  (Dec. 4)
• Military Family Tax Relief Act (Nov. 11)
• Jobs and Growth Tax Relief Reconciliation Act of 2003 (May 28)

CCH can assist you with stories, including interviews with CCH subject experts. Also, the CCH Whole Ball of Tax 2004 is available in print. Please contact:
 
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
 
Neil Allen
(847) 267-2179
allenn@cch.com

For Now, The Fix Is In on AMT

(RIVERWOODS, ILL., January 2004) – For many people, this April will bring a pleasant surprise. Lower tax rates, a larger child credit, breaks for joint filers and more favorable treatment of capital gains and dividends will trim the tax bills of many millions of filers. As a bonus, thanks to Congress, many will also be spared having to cope with the insidious alternative minimum tax, or AMT, for another year or two. But sooner or later, the AMT threatens to take some of the joy out of many people’s tax cuts, according CCH INCORPORATED (CCH), a leading provider of tax law information and software. That’s because cuts in the regular income tax actually increase the exposure of middle- and upper-income taxpayers to the alternative tax.

Quite simply, the AMT is an alternate way of figuring your income tax. It’s the legacy of an era when tax rates went as high as 91 percent and the tax code was full of loopholes for the wealthy, according to Mark Luscombe, JD, CPA and principal federal tax analyst for CCH.

"At that time, every tax season brought news accounts of fabulously wealthy individuals who paid no tax whatsoever. The system that eventually was devised is basically a parallel tax universe. Things that are deducted in figuring regular tax are often added back in figuring AMT, and things that are added for regular tax purposes may be subtracted," Luscombe said.

Doing Taxes Twice

For taxpayers, it means doing your taxes twice: You figure your regular federal tax, then calculate AMT and pay whichever is greater. Many items can trigger an AMT liability – and change character when you leave the "normal" 1040 world and enter the world of the alternative minimum tax. The itemized deduction for state taxes isn’t subtracted from income in figuring AMT, so residents of high-tax states – such as New York or California – are more likely to find themselves subject to the tax.

"Miscellaneous" itemized deductions aren’t allowed in figuring the AMT, either. This can affect taxpayers with large amounts of unreimbursed business expenses or who deduct the attorney’s fees they pay out of damage awards they receive.

Special rules apply to medical expenses, home mortgage interest and investment interest deductions. For example, an itemized deduction for the interest on a mortgage that pays for your home or for home improvements is deducted for both regular tax purposes and AMT, but if you borrowed against your home to buy something else, the interest is not deductible on the AMT form.

In addition, personal exemptions are not allowed in figuring the AMT. In one noted case, David and Margaret Klaassen of Marquette, Kan., claimed 10 personal exemptions for their kids, plus one each for themselves in 1994. The IRS then figured their alternate tax, without the 12 personal exemptions, and sent them a bill for $1,085.

The Klaassens petitioned the Tax Court to declare that imposing the AMT on them was contrary to the congressional intent behind the alternative tax. They did not have a single "tax preference" item on their return. Nonetheless, the Tax Court ruled in 1998 that they owed the tax.

Stock Options Can Trigger AMT

During the stock market bubble years, the AMT brought extra anguish for those who saw their dot-com stock option fortunes disappear. When a company awards incentive stock options to employees, the recipients have to treat the value of the stock as income for AMT purposes. If the stock plunges in value before the holder can actually sell it and realize the hypothetical windfall, that’s too bad – the AMT bill still has to be paid.

"There undoubtedly have been people who’ve escaped from the market owning just their home, only to find out that they will have to sell it to pay the tax bill on ‘income’ they never actually saw," Luscombe said.

About a dozen other items, mainly related to businesses, can change things enough to incur an AMT liability. For the AMT, depreciation is figured differently than for normal tax, and the difference becomes an "adjustment" to income – although the adjustment sometimes leads to a lower AMT liability. No single factor may be decisive. As they approach higher income levels, taxpayers must discover for themselves if AMT applies.

Indexing and Nonindexing Increase AMT Exposure

The AMT has its own exemption amounts and tax brackets, but unlike their counterparts in the regular tax rules, numbers associated with the AMT have not been indexed for inflation. In fact, the indexing of various items for the purpose of regular tax – such as tax brackets, the standard deduction and personal exemptions – has a downright perverse effect on AMT liability, according to Luscombe.

"Indexing means that at any given level of income – say, $90,000 – you’ll owe less regular tax next year than you did this year," he said. "But since AMT computations generally don’t use indexed figures, the AMT on that same level of income would stay the same. This means that the excess of your regular tax over AMT – the cushion that protects you from having to figure and pay the AMT – gets less and less at any given level of income, until you could find that you owe the AMT."

A Temporary Fix for the AMT

A series of tax reductions that started in 2001 will actually expose more people to the AMT in the future, precisely because they lower regular taxes.

To delay the date when AMT might start to eat away at the tax cuts for many people, Congress, in 2001, temporarily increased the exemption amounts used in figuring AMT for the tax years 2001 through 2004, from $45,000 for joint filers to $49,000. It also allowed taxpayers to take the child credit and adoption credit against the AMT. Other nonrefundable personal tax credits, such as the Hope and lifetime learning credits, could be taken against AMT liability through the end of 2003.

When the tax cuts of the 2001 legislation were accelerated in the Jobs and Growth Tax Relief Reconciliation Act passed in 2003, Congress heaped on additional AMT relief. The exemption was boosted again, this time to $58,000, for the 2003 and 2004 tax years.

But when these temporary "fixes" begin to expire at the end of next year, many taxpayers will find that their taxes will go down, but only as far as the AMT will allow.

"The law gives some temporary protection from the AMT for a few years, but in the end, the alternative tax is likely to limit the tax reductions that many people can expect," Luscombe noted. "As regular tax rates fall, more taxpayers will find themselves stranded on the AMT."

Numbers Tell the Story

When the IRS first reported figures for tax year 2000, the last year before the recent round of regular tax cuts and AMT "fixes," they showed a 30-percent jump in the number of returns with an AMT liability over comparable numbers from 1999.

Comparable preliminary figures for tax year 2001 show that the fixes seem to be working. About 185,000 fewer returns showed any AMT liability for 2001 – a decline of about 14 percent.

The Joint Committee on Taxation expects about 2.4 million tax returns to show an AMT liability this tax year and about 2.9 million in 2004. Then, when the AMT exemption amounts go back to their pre-tax cut levels, the alternate tax widens its reach: 11.3 million returns in 2005, 14.9 million in 2006, soaring up to 30 million in 2010.

In 2011, the committee forecasts that the number affected by the AMT will be roughly cut it half – but that’s because the tax cuts begun in 2001 are scheduled to come to an end. If they live on beyond their current expiration date, the Congressional Research Service estimates that 41 million taxpayers would be affected by the AMT in 2012 – 37 percent of all the returns filed.

Abolish the AMT?

One obvious way to end the perceived inequities of the alternative tax – and to deliver the full benefits envisioned by the recent tax cuts – would be to eliminate the AMT once and for all. Abolishing the personal AMT itself is a relatively cheap step to take right now – the tax amounted to only about $5.9 billion for the tax year 2001 compared to total individual income tax receipts of $892 billion.

But its contribution to the nation’s finances will grow over time. The Congressional Research Service estimates that the cost of total repeal could be as much as $840 billion from 2003 to 2012, while simply indexing the AMT for inflation would cost at least $400 billion.

"By limiting AMT relief to a few years, Congress lowered the cost to the treasury of the 2001 and 2003 tax cuts," Luscombe noted. "If there were no AMT, projected budget deficits would be larger and extend further into the future."

It seems likely, then, that a tax whose relevance is questionable and whose operation can be quirky will continue to function in some way or another in the nation’s tax scheme.

"Congress has taken a band-aid approach to the AMT so far," Luscombe said, "but that fits with the general picture. Taxes as a whole are a patchwork right now, with rates falling, then rising, then falling again, then rising. Unless Congress changes dramatically, we can expect a variety of temporary fixes involving the AMT to be the rule for some time to come."

About CCH INCORPORATED

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served more than four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, accounting, legal, securities and small business markets. CCH is a Wolters Kluwer company. The CCH Federal and State Tax group, CCH Tax Compliance and Aspen Publishers Tax and Accounting group comprise the new Wolters Kluwer Tax and Accounting unit. The unit’s web site can be accessed at tax.cchgroup.com.

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