Tax quirk can mean bigger bill

Rule never intended to hit mid-level earners

Author: Marilyn Geewax

Published: April 10, 2005

This tax-filing season, many Americans are getting a rude shock.

After figuring their 2004 income taxes, they're being told they have to do it all over again, filling out a form that the Internal Revenue Service estimates will take three hours and 53 minutes to complete. The result for about 3.5 million of them: a higher tax bill, sometimes far higher.

And unless something is done, this parallel tax system threatens to mushroom by 2010, affecting two-thirds of taxpayers with incomes between $50,000 and $200,000.

The culprit is the Alternative Minimum Tax, a tax-code quirk never intended to target middle-income families.

But the 1969 law failed to take inflation into account. As a result, by 2008 it will cost more to repeal the AMT than to zero out the regular income tax, according to the Tax Policy Center, a joint venture of the Brookings Institution and Urban Institute, two research groups.

Yet tax experts say finding a permanent fix may be politically impossible because the AMT generates revenues that the deficit-ridden government sorely needs.

Rather than blow a gigantic hole in the budget, they say, Congress likely will punt the problem away, hoping that someone, someday, somehow figures out a real solution.

``There is not much political will to do anything about it,'' said Leonard Burman, co-director of the Tax Policy Center. ``My best guess is they'll keep on doing what they have been doing for the last few years, which is pass temporary patches, one year at a time.''

Sen. Chuck Grassley, R-Iowa, chairman of the Senate Finance Committee, said he is resigned to passing another temporary fix by raising the dollar threshold for incomes affected by the AMT. He promises to seek a long-term solution in 2006.

``I hope this is the last year we'll have to enact a one-year patch,'' he said in an e-mailed response to questions about the AMT.

The AMT law was written in response to a Treasury report to Congress showing that in 1967, 155 wealthy families with incomes above $200,000 (about $1.14 million in today's dollars) had used various shelters and loopholes to avoid paying taxes.

Fearing a revolt by middle-class taxpayers, Congress moved to make sure the very rich couldn't escape taxes entirely. It approved legislation requiring Americans to calculate their taxes under the usual rules, then do it again under the AMT rules. Those alternative rules wipe away most deductions and the $3,100-per-child exemption.

The taxpayer must pay whichever is larger, the regular tax bill or the one calculated under the AMT.

Over the years, the growth of wages has made more taxpayers subject to the AMT. Meanwhile, property values have shot through the roof, forcing many average families to pay extremely high property taxes.

In some places where homes are expensive, a couple earning as little as $75,000 could become ensnared in the AMT by the time they take their deductions for property, state and local taxes and exemptions for children.

``There are middle-income families who clearly were never intended to be affected, but they are being affected,'' said David Kamin, a federal tax expert with the Center on Budget and Policy Priorities, a research group that focuses on how tax policy affects low- and moderate-income families and individuals.

``As we look out over time, by 2010, for people making $75,000 to $100,000, about half in that range would be affected if nothing is done,'' Kamin said.

By contrast, a much smaller percentage of taxpayers earning $500,000 or more are affected, because their marginal tax rates are already higher than those of the AMT.

Internal Revenue Service Commissioner Mark Everson, speaking recently with a group of reporters, said he believes Congress and the White House should make reforming the AMT the top priority.

``I agree with all those who call for a way to get rid of this two-track system,'' he said.

That's because the AMT fosters a disrespect for the tax code, he said. ``It's sort of horrific that somebody could try to navigate the whole system, get down to the bottom and then we say, `Oh, just kidding. You really have to pay $2,000 more because of the AMT.' ''

President Bush's latest budget did not address the AMT because he plans to take on the issue next year during a larger revamping of the tax code. Earlier this year, he appointed the Tax Advisory Panel, which is weighing options for making the code simpler.

But that doesn't mean that Bush and other political leaders are rushing to slay the AMT dragon.

Some Democrats believe Republicans don't focus on the issue because it primarily hits high-tax ``blue'' states that did not vote for Bush in last year's election, such as California, Connecticut, Maryland, Massachusetts, New Jersey and New York.

Also, without the budget padding of the AMT, it would be harder for Bush to reach some key goals, such as cutting the federal deficit in half by the end of his term and preserving a raft of tax cuts he has won.