The Alternative Minimum Tax (AMT) was created in 1969. It originally targeted higher income federal taxpayers who generally paid little or no income tax by using advantages in the regular income tax code. Because the AMT has not been indexed for inflation, more taxpayers are falling under its domain. This number is only expected to increase over the years. Congress has considered making changes to the AMT because of this situation.

Historical Background of the Alternative Minimum Tax

Congress passed the AMT as part of the Tax Reform Act of 1969. This tax was supposed to ensure that wealthy taxpayers who had used legal tax avoidance techniques would pay federal taxes. The original AMT was modfied by the Revenue Act of 1978 to include an add-on minimum tax. The basic form of today's AMT was created by another modifying law, the Tax Equity and Fiscal Responsibility Act of 1982. This law repealed the add-on minimum tax, adjusted tax preferences, and expanded the AMT.

Who Is Affected by the Alternative Minimum Tax Today

The original AMT was supposed to ensure that wealthy taxpayers did not benefit from tax avoidance techniques and paid some federal income tax. Today, however, the top tax brackets are not particularly impacted by the AMT. If you make more than one million dollars from investments, the impact of the AMT is usually minimal. Instead, it is generally middle class taxpayers who are paying more in taxes because of the AMT. One concern about the AMT is its apparent inequality among taxpayers.

How the Alternative Minimum Tax Works

When completing tax forms, taxpayers who have certain types of income exempt from regular tax are forced to recalculate their liability using the AMT. The AMT does not let such taxpayers use standard exemptions, deductions, and other tax preferences that are used for standard federal income taxes, but has its own tax rates and credits. After calculating both your regular tax and AMT liabilities, the taxpayer must pay whichever is higher. Every taxpayer must figure out if they owe the AMT, in theory.

If the taxpayer is not itemizing their deductions, the AMT is calculated by subtracting the AMT exclusion from their adjusted gross income. The taxpayer then applies the AMT two-step tax rate to the adjusted gross income. Itemizing deductions makes the process more complicated. To figure out taxable AMT income, a taxpayer must add personal exemptions and specific deductions (such as state and local taxes and unreimbursed business expenses), then subtract the appropriate AMT exemption. The AMT two-step tax rate is then applied.

Differences between the Alternative Minimum Tax and Regular Federal Income Tax

The AMT and regular federal income tax differ in how taxable income is determined, as well as how deductions and exemptions are claimed. The AMT does not allow personal exemptions or standard deductions found in the regular federal income tax. The AMT does give taxpayers a pre-determined exemption amount, however. There are also a few tax preferences and adjustments to modify the income amount subject to taxation under the AMT that are not found in the standard federal income tax. In addition, the AMT rate is generally higher than the regular tax rate.

Situations That Force Taxpayers into the Alternative Minimum Tax

The AMT is triggered by certain events that affect income and/or tax bracket. These situations potentially include:

• paying an extraordinary amount in state and local taxes.
• paying a significant amount of foreign taxes.
• having a family with many children.
• having a large number of unreimbursed employee expenses.
• incurring a significant amount of unreimbursed business costs.
• gaining income from investments.
• exercising incentive stock options.
• winning a lawsuit with a settlement.

Challenges for Taxpayers Who Must Pay the Alternative Minimum Tax

In addition to not being indexed for inflation, taxpayers who are forced to use the AMT face challenges. Some of these include:

• completing AMT forms in addition to regular tax forms.
• calculating the AMT with differing definitions of income, deductions, and exemptions.
• needing an accountant to fill out paperwork because of the AMT's complexity.
• paying the AMT, and being forced to pay it again and again.

Bringing Change to the Alternative Minimum Tax

The number of middle-class taxpayers forced to pay the AMT continues to increase. It is believed that in the near future, about half of the taxpayers in the United States will pay the AMT unless there are changes. There have already been many changes proposed to fix the AMT, including:

• increasing the exemption amount for the AMT.
• allowing dependent exemptions.
• allowing the deduction of state and local taxes.
• eliminating or scaling back the economic causes of applying the AMT to non-wealthy taxpayers.
• creating a new exclusion threshold for the AMT so middle-income taxpayers would not be subject to the AMT.
• indexing the AMT for inflation.
• eliminating the AMT entirely.

There have been many calls to modify the AMT, but there are several reasons why little has been done. The most prominent reason is the cost in lost tax revenue and its negative impact on the federal budget. Many taxpayers, experts, advocates, and members of Congress are critical of the AMT and its affect on taxpayers.

Additional Resources:

• Center of Budget and Policy Priorities:               http://www.cbpp.org
• Congressional Budget Office:                            http://www.cbo.gov
• Fairmark.com Web site:                                     http://www.fairmark.com
• Internal Revenue Service:                                   http://www.irs.gov
• Tax Policy Center:                                             http://www.taxpolicycenter.org