You've probably gotten used to stories of government bureaucracy and inefficiency. But now, waffling among lawmakers will hit everyone where it hurts: in the wallet.
Elected representatives have decided this year to play chicken with the alternative minimum tax (AMT), a controversial tax provision that was created to make sure that all taxpayers paid at least some taxes regardless of deductions or other tax breaks. The original law included an exemption from the AMT that was high enough to tax only those with relatively high incomes.
Because that exemption was never indexed for inflation, however, the AMT now threatens to capture middle-class taxpayers. For years, Congress has passed temporary increases to the exemption amount -- often at the last minute -- to mitigate the impact of the AMT.
Beyond the 11th hour
This year, lawmakers seem determined not to resolve the AMT issue until the last possible moment. With four weeks left in the year, Congress hasn't yet passed a so-called "AMT patch" to give taxpayers their much-expected relief. Instead, a more extensive proposal has called for outright repeal of the AMT along with a general cut in the corporate tax rate. In exchange, high-bracket tax rates would rise, and certain perceived loopholes would be closed, including the 15% rate on carried interest that benefits managers of private-equity firms like Blackstone Group (NYSE:BX) and Fortress Investment (NYSE:FIG). That proposal is unlikely to pass, but it has framed the debate in a way that makes it harder to get a plain AMT patch through Congress.
Without a patch, you might end up owing as much as $4,000 to $5,000 more than you might have expected. Yet the problem has gone beyond merely who pays the AMT. The Treasury has said that because lawmakers are waiting until the last minute to make significant changes, the IRS may not be able to process early tax returns, which taxpayers typically file if they're expecting large refunds. What that means is that even if the AMT has absolutely no impact on your taxes, you might end up having to pay for AMT gridlock in the form of a delay on your refund -- money that no one disputes is owed to you.
What to do
If there's a chance that you owe AMT, you should think about its potential effects now. The most likely reason you'll have to pay AMT is if you have certain types of deductions that don't get counted for AMT purposes, such as real estate and state income taxes.
In general, it often pays to pay those taxes early in order to pull a potential tax deduction into the current year. But if you're stuck paying AMT, it actually makes sense to wait, since you won't be able to claim that deduction by paying early. The problem, obviously, is that if you're right on the fringe of the tax right now, your decision may hinge on whether that patch gets passed.
As for tax refunds, there's probably not a lot you can do this year. For 2008, however, let this serve as a reminder that you're better off keeping more of your paycheck for yourself than letting the IRS have an interest-free loan that gets repaid in your tax refund. By adjusting your withholding and estimated tax payments to get you closer to the amount you actually owe, you won't have to worry about whether the IRS will pay your refund on time. You'll already have that money to use, however and whenever you wish.
And to end on a positive note, you can probably expect this to be just the first in a series of similar yet more extensive deliberations to come in future years. With many previous tax cuts set to expire in coming years, there are no guarantees that they'll be extended. A massive tax increase might result simply from government inaction. Unfortunately, the one thing that people from every political viewpoint can agree on is that it's easy for lawmakers to get stuck in gridlock.
For more Foolish insight into tax issues, read these:
- What the 2008 candidates will do to your taxes.
- How the IRS has added insult to injury in the housing debacle.
