A tax aimed at the rich now hits the masses

Author: Mary Deibel

Published: April 5, 2005

Ron and June Speltz considered themselves lucky when Ron's high-tech employer awarded him hefty stock options - only to have Uncle Sam hit the Iowa couple with a $210,065 tax bill for money they never saw.

The Speltzes fell prey to the Alternative Minimum Tax, or AMT, a parallel tax system that Congress enacted in 1969 in response to 155 super-rich citizens who paid no federal income taxes.

The AMT hasn't been adjusted for inflation in the last 36 years the way regular income tax brackets have been, so now it will hit 3 million taxpayers with tax bills that average $3,000 more than they expected to pay. People with big families and those from high-tax states and with big capital gains are especially vulnerable.

In the Speltzes' case, the $800,000 in stock options he received plunged in value to $1,647 when the dot-com bubble burst. The upshot: The federal tax bill of $210,065 prompted June to take a job and the Speltzes to sell their house and move to a smaller place with their three daughters to pay off part of their tax liability.

While they still owe $148,744 they offered to pay only $4,457. The Internal Revenue Service said that wasn't enough, and the U.S. Tax Court sided with the IRS.

"Being forced to pay more than 11 times what the normal taxpayer would pay in taxes is destroying us financially and has caused immense stress," Ron Speltz says.

You could find yourself in the same place even if you don't have stock options: The AMT is projected to catch almost 35 million households - or 1 in 3 Americans - by 2010, including people making as little as $50,000 a year.

The AMT eliminates dependent exemptions of $3,100 a child plus deductions for state and local taxes and home equity debt that's taken out for reasons other than home improvement. You also lose miscellaneous deductions for everything from un-reimbursed business and home-office expenses to investment and tax-preparation fees, safe-deposit rent and gambling losses.

"It's a class tax that became a mass tax," said Len Burman, co-director of the non-partisan Tax Policy Center that has studied the AMT in depth.

IRS National Taxpayer Advocate Nina Olson gives top priority to fixing the AMT and knows firsthand it's "the elephant in the room." Olson herself got bagged last year by the alternative tax, which requires taxpayers to fill out a 12-line worksheet, read eight pages of instructions and complete a 55-line form simply to see if the AMT applies to you.

A permanent fix would cost $600 billion to $700 billion in the first 10 years, by congressional estimates. President Bush's 2006 budget doesn't propose a future fix, leaving the issue to his tax reform commission.

Skeptical observers note that the alternative minimum tax generates billions of dollars in extra tax revenues and holds down the deficit: If 3 million taxpayers today owe Uncle Sam $3,000 more in taxes than they otherwise would, imagine if 35 million taxpayers are paying the AMT by 2010. Tens of billions of extra tax dollars will flow to federal coffers each year without Congress or the White House lifting a finger.

A further benefit for a Republican White House and a Republican Congress is that the AMT hits hardest at high-tax "blue" states, starting with Democratic California, New York and New Jersey. One notable exception is toss-up Ohio, No. 3 on the Tax Foundation's state-and-local tax burden chart.

"The one good thing about the AMT is that it's quite simple to follow and administer," former IRS Commissioner Donald Alexander says. "It's also quite unfair because it raises people's tax bills and they must figure their taxes twice."

Current IRS Commissioner Mark Everson agrees that the AMT raises taxpayer ire "because you get down to the bottom of your tax form and it says, 'Just kidding: You have to pay $2,000 or $3,000 more just because of the AMT.' "

Everson says the solution lies not with the tax collector but with Congress and the president, who write the tax laws.

Doug Larkin of the Coalition for Tax Fairness, which represents the Speltzes, contends the IRS has leeway to solve problems faced by taxpayers unfairly hit by the AMT through its "offer-in-compromise" program. "It's the hammer on the workbench that the IRS chooses not to pick up," Larkin says.

Meantime, the Speltzes plan to appeal the Tax Court judgment and hope that Congress and the president provide AMT relief for people with non-existent stock option profits and other families who aren't super-rich tax.