Investors are looking at the ever-more closely looming fiscal cliff with increasing concern, as economists warn about the potential dangers of allowing huge tax increases and spending cuts to take effect when the recovery is already on fragile ground. Yet while almost everyone's attention is squarely on rising tax rates in 2013 and long-term solutions to entitlement programs, one big potential bump in the economic road has already happened -- and the government needs to do what everyone already expects it will do and fix the problem before it threatens to throw the U.S. economy into a tailspin.
Alternative minimum tax: Not just for rich people anymore
The alternative minimum tax isn't something that most people pay much attention to. The AMT was originally designed to ensure that wealthy people paid at least a certain minimum amount of tax, regardless of how many tax deductions and income shelters they used to try to reduce their tax bills.
Over time, though, the AMT has affected more and more people. That's primarily because most of the dollar amounts that the AMT refers to in calculating the tax are fixed amounts that aren't indexed for inflation. As a result, slowly but surely, more taxpayers have become subject to AMT, with an estimated 4 million having paid the tax in 2011. That number would have been far larger if Congress hadn't traditionally made inflation adjustments to the AMT.
At the beginning of 2012, provisions that called for automatic increases to the amount of income exempt from the alternative minimum tax expired. As a result, under the tax law that has governed taxpayers throughout this year, AMT exemption amounts fell by 30% to 40%.
On past occasions, Congress has gone back and retroactively raised exemptions on the AMT in order to avoid problems. Indeed, most taxpayers have assumed that this would be the case in 2012 as well. Yet with two weeks to go in the year, Congress hasn't yet chosen to get the job done, and now, analysts are looking closely at the fallout that could result from a continuing failure to act.
The IRS has said that without a patch, as many as 60 million Americans could be affected by the AMT, with 33 million of those potentially having to pay the tax. Calculations of the average AMT tax burden among those taxpayers vary, but with a typical increase being in the $3,500 to $4,000 range and the maximum hit closer to $8,000, it's not an insignificant amount.
The most obvious business impact of a higher AMT would be on retailers catering to customers with incomes in the $200,000 to $500,000 range, as they're typically the ones who bear the biggest part of the AMT burden, and so their increases in the tax are likely to be the biggest. Michael Kors (NYSE:CPRI), Coach (NYSE:TPR), and Nordstrom (NYSE:JWN) are among the businesses that have had the most success catering to the rising affluent -- those who aren't filthy rich but who aspire to become so -- and could therefore take the biggest hits from a reduction in their fortunes.
Yet even those who don't have to pay the tax could suffer. The IRS has said that even among those who end up not having to pay the tax, 2012 tax refunds could get delayed. That's even true if lawmakers eventually do fix the issue, since the IRS would have to go back and change all of its tax forms to accommodate whatever rules lawmakers end up enacting. With the IRS having paid almost $213 billion in refunds during the first quarter of 2012, a three-month delay in processing refunds could be devastating to the short-term health of the economy, reducing disposable income and posing particular problems for Best Buy (NYSE:BBY), Ford (NYSE:F), and other sellers of big-ticket items that rely on refund checks to pay for down payments.
Get it done
Unlike other fiscal cliff issues, both parties have historically supported legislation to "patch" the AMT. Lawmakers shouldn't wait for a grand compromise on tax policy writ large before fixing this isolated problem, given the huge impact it could have on the broader economy. If lawmakers can't give taxpayers any certainty about what 2013 will bring, it can at least give them that certainty for 2012 by fixing the AMT now. Not doing so risks the very real possibility of exactly the economic problems lawmakers have worked so hard to avoid.