There are many unfortunate provisions in the tax reform bills recently passed by the House and Senate, but at least one good one: the House bill would repeal the alternative minimum tax. The Senate bill, in an effort to find some revenue, would preserve the AMT but reduce its bite somewhat.
As a professor of tax law, I am aware of many terribly flawed tax rules. But no feature of the Internal Revenue Code strikes me as less rational than the modern AMT. Congress created the AMT in 1969 to impose at least some income tax on what committee reports described as “a small minority of high-income people” who had manipulated the then-current rules “to evade tax on a large part of their income”. Lawmakers revised the rules to target deductions for “tax preference items,” such as mineral depletion allowances, intangible drilling costs and accelerated depreciation, as well as a special deduction then available for income capital gains.
The central idea was to impose a lower tax rate, but on a broader tax base, stripped of most deductions. For a while, it mostly worked. The AMT was a nuisance to a few high-income earners—never more than 0.5% of all taxpayers in the early years—but was otherwise largely harmless. Yet through a series of small, unintended steps, the AMT has become both broader and less focused on wealthy tax evaders.
In 1978, Congress effectively removed capital gains preferences from the scope of the AMT. Since very high-income taxpayers take more than half of their income in the form of capital gains, this has largely made them immune to AMT.
In 1981, Congress indexed regular tax brackets and exemptions to automatically adjust for inflation, but did not add AMT-like indexing. In 1986, Congress significantly reduced regular tax rates, but not AMT rates.
The result is that the effect of AMT today is quite at odds with its expressed intent. In 2015, about 4.5 million taxpayers, or about 3% of total filers, paid it, according to official IRS estimates. Most of these people were well off but not super wealthy. Less than 20% of taxpayers with adjusted gross income over $1 million paid AMT, compared to about 60% of those with income between $200,000 and $500,000.
The afflictions of this latter group do not quickly bring handkerchiefs to tear-soaked eyes. Nevertheless, even high earners deserve a tax that is fair and based on rational theory, and the AMT is neither.
Although intended to target very wealthy taxpayers, the AMT creates collateral damage. Consider David and Margaret Klaassen, whose income in 1994 was just $83,000. They were hit by the AMT simply because they paid local and state taxes and because they had 10 children. Regular tax calculations allow deductions for state and local taxes and personal exemptions, but not AMT. The result was that the Klaassens’ AMT exceeded their regular tax by 20%. They challenged AMT’s assessment and fought the IRS. Although a federal court agreed that it was patently unfair to impose AMT on taxpayers who were clearly not its original targets, it ruled that the Klaassens should nonetheless pay it.
AMT is also a compliance nightmare. It imposes alternative calculations on a wide range of items, forcing taxpayers (or their accountants) to wrestle with two separate sets of tax rules. IRS Form 1040 indicates that if taxpayers are unsure whether they owe an AMT, they must complete a 16-line spreadsheet to make a preliminary determination. If the spreadsheet suggests the answer may be yes, taxpayers are advised to complete Form 6251, which is 64 lines long and even more complicated. Thus, even many taxpayers who do not pay the AMT in the end are forced to grapple with its complexities.
In the interest of full disclosure, I should note that my wife and I paid AMT for over a decade. But even if a tax bill that eliminates the AMT leaves me paying the same amount, it would be a win for me and millions of other Americans.
As the conference committee begins to negotiate to reconcile the two bills, the best approach is apparent. The home plan eliminates these problems by eliminating the AMT. The Senate bill offers some relief, but does nothing fundamentally to fix a tax provision that badly needs to be repealed.
Mr. Schmalbeck is a professor of tax law at Duke University.
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