Stalemate on Minimum Tax Would Cost Region's Households

Author: Ford Fessenden

Published: December 11, 2005

Rob Cantor was doing well financially, or so he thought. College tuition for his two daughters was devouring his annual bonus, not to mention the $5,000 to $7,000 tax refund he got back every year from the federal government. But with just a few years of tuition left, he allowed himself to dream of flush days ahead.

Even when most of his usual tax refund disappeared in 2004, he was unfazed. "Last year, I only got $1,000, and I thought, hmmm," said Mr. Cantor, 54, a software engineer who lives in Teaneck, N.J. "But my wife had gone back to school and is now a physician's assistant, and her salary substantially increased, so we were O.K."

This year, though, his accountant called after preparing their return and said, "You're not going to like this."

"I thought, maybe my refund is down to $200," said Mr. Cantor. "But he said, 'You owe $8,000.' I was floored."

Mr. Cantor and his wife, Susan Kirschenbaum, had lost many of their itemized deductions to the alternative minimum tax, a complicated calculation once aimed at the very rich but now creeping steadily down to the middle class as family income has risen.

It has long been known that the New York metropolitan region, with its wealthy enclaves, high taxes and rising home values, is one of the areas hardest hit by a tax formula that essentially does away with deductions. But a new statistical analysis shows that about 400,000 households in New York City and the suburbs in New York, New Jersey and Connecticut pay the alternative minimum tax - one of every eight payers of the tax in the nation, according to figures from the forecasting firm economy.com. The region is home to about 1 of every 14 taxpayers in the nation. For the average taxpayer in the $100,000 to $200,000 income bracket, the alternative minimum tax means an additional $2,200 in federal income taxes.

As Congress looks for ways to reduce deficits and reform the tax code, the middle class deductions that Mr. Cantor and hundreds of thousands of others in the metropolitan area have relied on are under a microscope. A temporary fix that has exempted millions of families from paying the alternative minimum tax expires this year.

The House and Senate, in intense negotiations last week on an overall tax package, passed extensions, though different versions. The Senate version sets a higher exemption and would keep an additional 75,000 metropolitan area households - and a total of 600,000 nationwide - from being subject to the alternative tax.

If the two houses cannot agree and the temporary fix is not extended, another 15 million taxpayers, more than 2 million of them in and around New York, may see an increase in their 2006 tax - which will show up on the returns filed in 2007 - the economy.com analysis shows.

"The breakdown of people who are hit by the tax is like a demographic profile of the population in the New York area," said Len Burman, co-director of the Tax Policy Center.

But even if the exemption passes, taxpayers like Mr. Cantor may face another threat to their deductions. A presidential advisory panel proposed last month doing away with the alternative minimum tax, and suggested making up the revenue by eliminating the deduction for state income taxes for everyone, and sharply cutting back deductions for mortgage interest as well.

No place in the country has more people taking those deductions than the suburbs of New York: 55 percent of households in Nassau County, for instance, claim more than the standard deduction, higher even than in superrich Marin County, Calif., and way above the national average.

"The tax system is broken, and any kind of reform will involve winners and losers," said Mr. Burman.

President Bush's advisory panel agreed that the tax was bad policy and should be abolished, and suggested a trade-off: abolish a number of popular middle-class deductions, including those for state income and property taxes. It would also sharply limit the tax savings on mortgage interest. Those ideas make the real estate industry apoplectic, especially around New York.

"It is grossly unfair geographically," said Kathleen Murphy, a real estate agent in Northport, N.Y. "Homeowners are like deer in the headlights now. They don't know what to expect from this market. It's not a marketplace where you want to add variables that detract from homeownership."

Abolishing the alternative tax and making up that revenue by curbing state tax and mortgage interest deductions could add more New York area households to the list of tax losers, according to Mark Zandi, chief economist at economy.com.

That seems unlikely to happen, though. It appears that Congress and Mr. Bush would be wary of such change.

Howard Neustadt, a projection engineer, is one of those who would be adversely affected, and he says the deductions are critical to him. Several weeks ago, he sold his home in Carmel, N.Y., and has signed a contract to buy one in Ossining, N.Y., for $560,000. The move will shorten his commute, and the math made just enough sense: even though his property taxes and mortgage interest will more than double, deductions for those expenses will save about $10,000 in taxes, making the new house affordable, if only barely.

"We could not afford this house without those deductions, and if the government does change this, we'd probably have to sell it," said Mr. Neustadt, 45, who has a combined income, with his wife, of $125,000.

The alternative minimum tax formula is complicated, but basically starts to snare people with incomes approaching $100,000 who have big deductions, like the five-figure real estate taxes that are becoming more common in the New York suburbs. The majority of people with incomes over $200,000 pay it.

The tax was enacted in 1969 to keep the rich from completely escaping taxes by disallowing certain deductions. A taxpayer calculates the tax the usual way, but then also calculates the alternative minimum tax by adding back exemptions for dependents, along with deductions for state income and property taxes, certain home equity interest, medical expenses, stock options and a litany of more- obscure items. An exemption that ranges from $29,000 to $58,000 is subtracted, and a flat tax rate of 26 or 28 percent is applied to the balance, which the taxpayer pays if it is higher than the tax calculated the normal way.

"We thought it would only affect people in the high-income ranges," said Pat Roeder, an Eastchester divorce financial analyst, who had an alternative minimum tax bill of $3,000 last year. She and her husband, Paul Chrystal, a contractor, earn about $150,000, but they are hardly rich, she said.

"We live in a modest-size house in a nice neighborhood," she said. "We get away on weekends sometimes, but we haven't taken a vacation in five years."

As middle class family incomes have risen into realms once inhabited only by the rich, the number of those subject to the alternative tax has increased. In 2003, it was 2.3 million people. The growth has been greatest in areas where property taxes and state income taxes are the highest.

"Five years ago, five percent of my clients were paying the A.M.T.," said Keith Amchin, Mr. Cantor's accountant. "Now, it's 20 to 25 percent."

Eugene Sidoti, a plastic surgeon, has four children and a home in Armonk, N.Y., all of which were helping to keep his federal tax bill down. But no longer.

"Until maybe four or five years ago, I never owed anything at the end of the year," said Dr. Sidoti. "And suddenly I'd get hit with big numbers, tens of thousands of dollars. I've now lost all my deductions, but now I see others who make far less falling into the category."

An analysis for The New York Times by economy.com shows that the alternative minimum tax hits taxpayers everywhere, but is concentrated in suburban areas like DuPage County, in Illinois, and Orange County, in California. Of the 25 counties with the highest proportion of alternative minimum tax payers, though, 10 are in New York City or its suburbs: Manhattan, Nassau, Westchester, Putnam and Rockland in New York; Bergen, Somerset, Morris and Hunterdon in New Jersey; and Fairfield in Connecticut.

"It reflects, first, the high level of income in these regions, and second, that the taxpayers use deductions liberally in part because of the state and local tax levels," said Mr. Zandi, the economy.com economist.

Eventually, economists say, the alternative minimum tax will engulf the majority of payers in the New York area. Its unpopularity extends beyond just those who have to pay it. "The A.M.T. is horrible policy," Mr. Burman said. "It's unfair, it's inefficient, and pointlessly complex."

For Mr. Cantor, already engulfed, the loss of his deductions has changed his outlook considerably. He had not yet had to borrow money for his daughters' college tuition, he said, and was looking forward to the possibility of an early retirement when they graduate. He now believes he will have to borrow to get his second daughter through school. "I've got to pay that off," he said. "I'm going to be working for a while."