The House of Representatives and the Senate have each offered their proposals for tax reform, and there are many areas in which the two proposals disagree. Yet one item that they share in common is their plan to repeal the alternative minimum tax. Many see the AMT as a tax that only affects the extremely rich, but the reality is a bit more complicated than that. Some wealthy taxpayers do stand to gain from AMT repeal, but some who would consider themselves upper-middle class in pricier areas of the country would also potentially see some benefit as well.
The history of the AMT
Various forms of the alternative minimum tax have existed since the 1960s, but the version of the AMT in current tax law took effect in 1982. The idea behind the AMT is to ensure that taxpayers with high income pay at least some minimum level of tax, regardless of how many deductions, credits, and other tax breaks they qualify to take.
For a long time, only the highest-income taxpayers fell under the alternative minimum tax. Over the years, more people became subject to AMT, because until very recently, the income limits at which the AMT became effective weren't indexed for inflation. Fortunately, the compromise between Congress and the White House in early 2013 permanently raised exemption amounts and indexed them to inflation in subsequent years, which largely solved the issue of AMT creep. Even so, some of those who consider themselves upper-middle class still have to pay the alternative minimum tax, especially in higher-cost areas.
How AMT works
One reason why people dislike the alternative minimum tax is that it requires you essentially to do a second set of tax returns. Some tax breaks that you can take on your regular income tax return aren't available under the AMT, while the AMT offers its own set of breaks in some cases. Either way, you have to pay whichever tax is higher.
For most taxpayers who are subject to the AMT, a couple of key differences between the two tax systems are the most common source of additional tax. One essential difference between the AMT and the regular tax system is that itemized deductions for state and local tax payments aren't available under the AMT. In addition, personal exemptions that taxpayers can claim both for themselves and for their dependent family members don't appear in the AMT system. As a result, higher-income taxpayers who live states that have high income and property taxes and who have large families are more likely to fall under the provisions of the alternative minimum tax. More subtle differences between the AMT and regular tax system also play roles in isolated circumstances.
Who wins from AMT repeal?
Interestingly, the benefits of the repeal of the AMT for many taxpayers might well get wiped out by the elimination of other tax breaks. Lawmakers are looking seriously at eliminating itemized deductions for state and local taxes, which would essentially give the ordinary income tax system the same treatment for those tax payments that the AMT has always given them. In other words, you might no longer have to pay AMT, but if the taxes you used to deduct are no longer deductible, then your ordinary tax might rise to match what you used to pay under the AMT.
That leaves wealthier individuals to benefit from alternative minimum tax repeal. President Donald Trump would have been one of those who would have benefited from AMT repeal in previous years, as his 2005 tax return included more than $31 million in alternative minimum tax. Although the supporting details weren't available to explain further why the Trumps had to pay so much in AMT, it's possible that the differences in treatment of real estate sales proceeds and depreciation of assets could have played a major role in imposing the tax.
With continuing debate on Capitol Hill about the tax plan, it's not guaranteed that any tax package will make it through Congress. Yet the one area on which Republican lawmakers seem to agree is that it's long past time for the alternative minimum tax to disappear, and if it does, upper-income taxpayers are the ones who will reap nearly all of the rewards.
The Motley Fool has a disclosure policy.