The Individual Alternative Minimum Tax (AMT): 12 Facts and Projections

THE INDIVIDUAL ALTERNATIVE MINIMUM TAX (AMT): 12 FACTS AND PROJECTIONS Leonard E. Burman, Julianna Koch, Greg Leiserson, and Jeffrey Rohaly June 30, 2008 Urban-Brookings Tax Policy Center The Urban Institute 2100 M Street, NW, Washington, DC 20037 The Brookings Institution 1775 Massachusetts Avenue, N.W. Washington, DC 20036 Urban-Brookings Tax Policy Center - ii - ACKNOWLEDGMENTS Funding for the general operations of the Tax Policy Center is provided by a generous consortium of donors, including the Annie E. Casey Foundation, Brodie Price Fund at the Jewish Community Foundation of San Diego, Charles Stewart Mott Foundation, Ford Foundation, George Gund Foundation, John D. and Catherine T. MacArthur Foundation, Rockefeller Foundation, Sandler Foundation, Stoneman Family Foundation, and private donors. THE INDIVIDUAL ALTERNATIVE MINIMUM TAX (AMT): 12 FACTS AND PROJECTIONS LEONARD E. BURMAN, JULIANNA KOCH, GREG LEISERSON, AND JEFFREY ROHALY1 Congress originally enacted a minimum tax in 1969 to guarantee that high-income individuals paid at least a minimal amount of tax. Under today’s alternative minimum tax (AMT), middle- and upper-income taxpayers must add a number of “preference items” to their taxable income, subtract a special AMT exemption, and calculate their tax according to the AMT rules. If the tax under those rules turns out to be higher than their regular income tax, taxpayers pay the difference as AMT. 1. The AMT is exploding. Unless Congress acts, 26.8 million taxpayers will be affected by the AMT in 2008. In 2007, only 4.1 million taxpayers owed the tax because of the temporary AMT “patch,” which has now expired. By comparison, in 1970, just 20,000 taxpayers were affected by the AMT. If the 2001–2006 tax cuts expire as scheduled at the end of 2010, 43 million taxpayers (almost two-fifths) will be hit by the AMT in 2018. If the tax cuts are extended, the number jumps to 57 million taxpayers (more than half) (tables T08-0094 and T08-0095). Burman is a senior fellow at the Urban Institute and Director of the Urban–Brookings Tax Policy Center (TPC). Koch is a project associate at the Urban Institute and TPC. Leiserson is a research associate at the Urban Institute and TPC. Rohaly is a senior research methodologist at the Urban Institute and the director of tax modeling for the TPC. Views expressed are those of the authors and do not necessarily reflect the views of the Urban Institute, its trustees, or its funders. Urban-Brookings Tax Policy Center - 1 - 2. The AMT is encroaching on the middle class. Although the AMT is highly progressive, the distribution of AMT liability will shift toward tax units with lower incomes. In 2007, tax units with $500,000 or more in income paid 50 percent of the tax; by 2010, they will pay only 18 percent. About 78 percent of households with incomes between $100,000 and $200,000 and 46 percent of those with incomes between $75,000 and $100,000 will pay the AMT by 2010 (compared with 3.6 percent and 0.6 percent in 2007) (tables T08-0096 and T08-0098). 3. The average AMT liability in 2007 was $6,577. Barring legislative action, the average is projected to decline this year to $3,264 as millions of middle-class families—that tend to owe a smaller amount of the tax—join the ranks of AMT taxpayers (table T08-0097). 4. There are two main factors behind the explosive growth in the AMT: it is not indexed for inflation and the 2001–2006 tax cuts cut regular income tax without a permanent AMT fix. The AMT is not indexed for inflation and, therefore, affects taxpayers with lower real incomes over time. The 2001–2006 tax cuts almost doubled the projected share of taxpayers who will face the AMT in 2010 from 17.8 to 34.8 percent. If the tax cuts had not been enacted and the AMT had been indexed for inflation along with the regular income tax in 1985, the number of AMT taxpayers would have remained between 300,000 and 400,000 through 2010 (table T08-0096). 5. The AMT raises effective marginal tax rates. Marginal tax rates affect the incentive to work, save, and comply with the tax system. In 2007, 72 percent of AMT taxpayers faced higher effective tax rates because of the AMT. In 2010, 89 percent will face higher rates (table T08-0099). 6. The AMT claws back the 2001–2006 tax cuts. In 2010, the AMT will take back a quarter of the regular income-tax cut that taxpayers otherwise would have received. More than 2 percent of taxpayers will have their tax cuts completely eliminated by the AMT. This assumes that the AMT remains in full force. If it is scaled back or eliminated, the tax cuts will be much more expensive than originally estimated (table T08-0100). 7. The AMT is notoriously and pointlessly complex. The Internal Revenue Service and the Taxpayer Advocate have flagged the AMT as one of the most complicated tax provisions to comply with and administer. Most people required to fi