There are many reasons to dislike the alternative minimum tax, which President Donald Trump has proposed to repeal in his current tax plan. But repealing the AMT may be just as bad as keeping it.
For one thing, it would contribute to a significant federal budget shortfall, and for another, its repeal may have unpleasant unintended — and intended — consequences to affected taxpayers.
The ostensible goal of the individual AMT is to prevent wealthy taxpayers from paying little to no federal tax. The AMT is a separate tax system with its own rules governing treatment of income and deductions.
It is determined separately, after the regular tax return is prepared. Whichever figure is higher is the tax amount due. (There is also a corporate AMT, also targeted for repeal.)
Since raising exemption levels and indexing them for inflation five years ago, there have been about 4 million constant people paying it, according to Jim Nunns, senior fellow with the Tax Policy Center. For example, in 2015, 4.4 million individual payers paid $26.4 billion, and of that, $22.5 billion was paid by those with $250,000 or more adjusted gross income, he said.
Nina Olson, U.S. Taxpayer Advocate and head of the Internal Revenue Service's Office of the Taxpayer Advocate, has been calling for a repeal of the AMT since 2001. In her 2013 Annual Report to Congress, she faulted the AMT because it:
- Has a disparate effect. The tax primarily affects taxpayers paying state and local taxes and those with children, because it disallows those deductions.
- "Hits the wrong taxpayers." For example, a single mother with income of $100,000 could be subject to AMT because it disallows her particular deductions and exemptions. Meanwhile, a childless investor with $100 million income in tax-free bonds will avoid the AMT.
- Taxes paper gains on exercised incentive stock options. If the gains disappear before the taxpayers sell the stock or pay the tax, they may be subject to AMT on phantom gains.
- Is less predictable. "Many taxpayers first learn they are subject to the AMT only after preparing their returns, when it is too late to increase their withholding or estimated tax payments," Olson wrote, which may result in unanticipated penalties.
While the president's current tax plan still contains many unknowns, the Tax Policy Center conducted an analysis of Trump's campaign plan and its budget impact in October of 2016. The report showed a number of big-ticket revenue-reducing items, including the AMT (–$413 billion), the introduction of three tax brackets (–$1.49 trillion) and increasing the standard deduction (–$1.68 trillion).
In the analysis, the individual income and payroll section of the budget resulted in a $3.3 trillion revenue deficit. Adding in the $2.7 trillion deficit created within the corporate tax section brings the net shortfall over 10 years to $6 trillion. The two primary offsetting revenue sources come from a repeal of personal exemptions (+$2 trillion) and capping itemized deductions (+$558 billion).
The campaign plan expected "proposals on trade, regulatory and energy policy would raise economic output and revenues" to offset most of the remaining shortfall, as cited by the Tax Policy Center analysis. In addition, the Center on Budget and Policy Priorities found that 59 percent of currently proposed budget cuts would come from programs serving low- to moderate-income populations.
"It's ironic, because if you look at his proposed tax plan, he is in effect leaving the AMT system in place," said Marianela Collado, CPA and CFP with Tobias Financial Advisors.
She explained that AMT income is calculated by taking total "taxable income" and adding back in the following deductions from Schedule A:
- Medical expenses in excess of 10 percent of adjusted gross income.
- State income and sales taxes.
- Miscellaneous deductions, such as tax preparation fees, investment management fees, etc.
Similarly, the president's plan eliminates all tax deductions except charity and mortgage interest, "but that's what the AMT is already," she said. Furthermore, the plan calls for just three tax brackets, of 10 percent, 25 percent and 35 percent (higher than the highest 28 percent AMT tax).
Folks who were paying 28 percent AMT on ordinary income may now end up paying 35 percent, so they could be worse off with the new plan, Collado said.
"At first, we thought AMT repeal would be great for our clients," said Leon LaBrecque, JD, CFP, managing partner and CEO of LJPR Financial Advisors. "But we noticed the changes in the standard deduction limit affected some of our AMT clients.
"Overall, some folks will really benefit from AMT repeal, but we can't look at taxes in a vacuum," said LaBrecque, also head of the Michigan Association of CPAs' special task force on tax changes, which ran simulations on more than 900 tax returns to see the impact of the proposed Trump tax changes. "Many of our clients are in AMT because of state and local taxes.
"Eliminating the AMT won't make that big a difference," he added.
LaBrecque points out that the so-called alternative minimum tax is actually a mandatory maximum tax that hits modestly wealthy people, those with incomes of $200,000 to $500,000 per year.
Perhaps a fix to the tax code is not in repealing AMT but keeping and expanding it, he said.
"On a philosophical note, maybe we should repeal the regular tax and make the AMT mandatory," LaBrecque said. "It's a flat-rate tax, something that may make sense.
"To my mind, I kind of like a flat-rate tax on upper income, with no deductions except charity."
— By Deborah Nason, special to CNBC.com