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Reginald Shareef is a professor in the Political Science Department at Radford University with a specialty in Public Administration, Leadership and Organization Change. His latest book, "Organizational Theory, New Pay, and Public Sector Transformations," addresses the politics of pay in government agencies. He has long been involved in public policy issues in Roanoke that range from public schools to urban renewal.
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Monday, May 17, 2004
Amount owed
By Dr. Reginald Shareef
ROANOKE.COM COLUMNIST
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MAY 17, 2004
Amount owed
By Dr. Reginald Shareef
ROANOKE.COM COLUMNIST
In 1969, Congress passed the Alternative Minimum Tax (AMT) after angry taxpayers bombarded Capitol Hill with letters and phone calls following media reports that 155 “super rich” taxpayers had not paid any taxes the preceding year.
In 2001, more than a million middle and upper-middle income taxpayers had to pay the AMT. That number is expected to grow to 30 million by 2010. Interestingly, very few ultra-rich Americans are now affected by the AMT.
How did such a reversal of fortune occur for the middle class?
The AMT is an extra tax some people have to pay on top of their regular income tax. Originally designed to prevent people with very high incomes from using tax benefits to pay little or no taxes, the AMT reaches far more people every year, including those with lower incomes and those who do not use special tax benefits. In fact, using common and legitimate deductions such as child care allowances or mortgage interest deductions can cause the unknowing citizen to pay the AMT.
The tax reality is that, based on income, every taxpayer has a minimum amount of tax he/she is obligated to pay. For lack of a better term, the tax code has a “flat tax” provision. If you are playing the flat tax minimum in regular taxes, you will not have to pay the AMT. Conversely, if your regular tax payments fall below the flat tax rate, you will have to make up the difference by paying the alternative tax minimum. That procedure can be very costly.
As Congress passes more tax cuts and allowable deductions, the amount of taxes the middle class pays is reduced. That’s normally a good thing, except taking all allowable deductions is putting more Americans below the flat tax fault line. These citizens then have to pay the AMT— which will be the equivalent of a personal financial earthquake.
Here’s why. Many of the deductions that are allowed under the regular income tax are disallowed under the AMT. Interest on a second mortgage is a good example. Say you have taken out an equity loan to purchase a condo for your child in college. Your plan is to pay on the condo for the years the child is in school, deduct the mortgage interest and then sell the condo in several years for a handsome profit.
However, if you use the equity loan interest deduction when filing your income taxes and it pushes you under the flat tax fault line, you will have to pay the AMT. And you will not be able to deduct the interest on the equity loan (second mortgage).
Medical expenses may also be disallowed under the AMT &$151; as would non-reimbursed employee expenses, tax preparation fees and many investment expenses. Tax-exempt bonds that are not exempt from the alternative minimum tax can make you a candidate for AMT liability, too.
Recent tax changes may also put you in AMT danger. The elimination of the “Marriage Penalty Tax” reduces the tax burden of married couples but could also send these couples to AMT purgatory. You can incur AMT liability for one big item (for instance, a huge deduction for medical expenses) or for several mundane items that appear on your federal income tax return such as state tax deductions or personal and dependency deductions.
Congress is in no hurry to change the AMT. The tax generates billions for the federal treasury each year. The fairest change would be to exclude households with incomes between $100,000 and $600,000 from the tax since these classes are not the (1)“super rich” nor (2) are using questionable tax gimmicks to avoid paying their tax responsibility. However, this is not likely to happen until most of this group is stung by the AMT and collectively howls to Congress over its mistreatment.
In the interim, the best way to protect yourself is to better understand your ATM threshold before you file taxes next year. Knowing that threshold/fault line will permit foregoing allowable deductions that you have enjoyed in the past. This will be difficult but the AMT makes paying taxes a zero-sum game for the middle-classes: forego the deductions and pay a smaller amount of taxes under the regular tax code; or take the deductions and face the AMT beast.
In the May 17 issue of Newsweek, business writer Robert Samuelson writes that, “It costs $100 billion to do our taxes because the system is so complex. The trouble is that both parties like it that way.” Put simply, Congress likes the average taxpayer not knowing that he/she is vulnerable to time bombs such as the AMT.
Samuelson also notes that most tax breaks favor the middle and upper-middle classes but that these allowances often don’t make economic sense. For instance, Americans are building ever-larger houses for ever-smaller families because housing is subsidized through the tax code.
Samuelson believes that as more Americans trigger the AMT, a more sober code will emerge. That is probably true. Paradoxically, as the middle classes learn and understand more about the AMT, fewer will cross that fault line and thus, there is a great likelihood that the tax will remain around for a longtime.
It will be interesting to see if middle-class Americans can prevail upon Congress before the “law of large numbers” forces revision of the AMT. At exactly what point will Congress blink? Hopefully, it will be soon rather than later.
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