The Ripple Effects of Trump’s Alternative Minimum Tax Repeal

There are many reasons not to like the alternative minimum tax, which President Donald Trump has proposed to repeal in his current tax plan. But repealing the AMT can be just as bad as keeping it.

On the one hand, it would contribute to a large federal budget deficit, and on the other hand, its repeal could have unintended – and intended – unpleasant consequences for the taxpayers affected.

The ostensible goal of the individual AMT is to keep wealthy taxpayers from paying little or no federal tax. The AMT is a separate tax system with its own rules governing the treatment of income and deductions.

It is determined separately, after the preparation of the regular tax return. The higher amount is the amount of tax due. (There is also a corporate AMT, also slated to be repealed.)

Since the exemption levels were increased and indexed to inflation five years ago, there have been about 4 million consistent people paying it, according to Jim Nunns, senior fellow at the Tax Policy Center. For example, in 2015, 4.4 million individual payers paid $26.4 billion, and of that, $22.5 billion was paid by those with an adjusted gross income of $250,000. or more, he said.

Nina Olson, US Taxpayer Advocate and Chief of the Office of the Taxpayer Advocate at the Internal Revenue Service, has been advocating for the repeal of the AMT since 2001. In her 2013 Annual Report to Congressshe blamed the AMT because she:

• Has a disparate effect. The tax primarily affects taxpayers who pay state and local taxes and those with children, as it prohibits such deductions.
• “Hit the bad taxpayers. For example, a single mother with an income of $100,000 might be subject to the AMT because she denies her particular deductions and exemptions. Meanwhile, a childless investor with $100 million income in tax-free bonds will avoid the AMT.
• Taxes paper earnings on exercised stock options. If the gains disappear before the taxpayers sell the shares or pay the tax, they may be subject to AMT on the phantom gains.
• Is less predictable. “Many taxpayers first learn that they are not subject to AMT until after they have prepared their returns, when it is too late to increase their withholding tax or their estimated tax payments,” said writes Olson, which can lead to unforeseen penalties.

While the President’s current tax plan still contains many unknowns, the Tax Policy Center conducted a analysis of Trump’s campaign plan and its budget impact in October 2016. The report showed a number of significant revenue-reducing items, including the AMT (–$413 billion), the introduction of three tranches of taxation (–1.49 trillion dollars) and the increase in the standard deduction (–1.68 trillion dollars).

In the analysis, the individual income and payroll section of the budget resulted in a revenue shortfall of $3.3 trillion. Adding the $2.7 trillion deficit created within the corporation tax section brings the 10-year net shortfall to $6 trillion. The two main sources of offsetting revenue come from the repeal of personal exemptions (+$2 trillion) and the cap on itemized deductions (+$558 billion).

The campaign plan called for “proposals on trade, regulatory and energy policy to increase economic output and revenues” to make up for most of the remaining shortfall, as the Tax Policy Center analysis cites. Moreover, the Center on Budget and Policy Priorities found that 59% of currently proposed budget cuts would come from programs for low- to moderate-income populations.

“It’s ironic because if you look at his proposed tax plan, he actually leaves the AMT system in place,” said Marianela Collado, CPA and CFP at Tobias Financial Advisors.

She explained that AMT income is calculated by taking the total “taxable income” and adding the following deductions from Schedule A:

• Medical expenses greater than 10% of adjusted gross income.
• State income and sales taxes.
• Miscellaneous deductions, such as tax preparation fees, investment management fees, etc.

Likewise, the president’s plan eliminates all tax deductions except for charitable and mortgage interest, “but that’s already what AMT is,” she said. Furthermore, the plan provides only three tax brackets, of 10%, 25% and 35% (higher than the highest AMT tax of 28%).

People who used to pay 28% AMT on their regular income may now end up paying 35%, so they could be worse off under the new plan, Collado said.

“At first, we thought the repeal of the AMT would be great for our clients,” said Leon LaBrecque, JD, CFP, managing partner and CEO of LJPR Financial Advisors. “But we noticed that the changes in the standard deduction limit were affecting some of our AMT customers.

“Overall, some people will really benefit from the repeal of the AMT, but we can’t look at taxes in a vacuum,” said LaBrecque, also head of the Michigan Association of CPAs’ special task force on Tax Changes, which ran simulations on more than 900 tax returns to see the impact of Trump’s proposed tax changes. “Many of our customers are on AMT because of national and local taxes.

“Eliminating the AMT won’t make such a big difference,” he added.

LaBrecque points out that the so-called alternative minimum tax is actually a mandatory maximum tax that hits the modestly wealthy, those with incomes between $200,000 and $500,000 a year.

Perhaps a solution to the tax code is not to repeal the AMT but to retain and expand it, he said.

“On a philosophical note, maybe we should repeal the regular tax and make AMT mandatory,” LaBrecque said. “It’s a lump sum tax, something that can make sense.

“In my opinion, I kinda like a higher flat income tax, with no deductions except charity.”

– By Deborah Nason, special for CNBC.com