Back in the 1960s Congress decided that too many wealthy individuals and their lawyers and accountants had devised clever, yet legal, schemes to avoid paying their share of income taxes. Although the tactics of shelters and loopholes were legal, lawmakers felt they weren’t fair. To remedy the situation, Congress decided (in their infinite wisdom) to implement yet another tax called the Alternative Minimum Tax (AMT).
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So in 1969, partly to raise revenues to fund the Vietnam War and partly to assuage public shock at the number of millionaires who were not paying income taxes at all, this new tax was levied on the wealthy. It was a flat 10% tax that ran parallel to the current income tax system.
Fast forward a couple of years and now we have an even more convoluted and complex formula to determine the amount of AMT to be added to a person’s regular income tax. The process goes something like this: If you have more than $50,000 in the bank, divide your account balances by your shoe size, add in your medical deductions for the year multiplied by your modified adjust gross income which is calculated by adding up all your taxable and nontaxable income, and dividing by the number of dependents claimed times the square root of your home office deduction.
Just kidding. Sort of.
The tax is difficult to understand and apply correctly. Below is the list from the IRS of the adjustments and tax preferences that the wealthy had taken advantage of that are added back to determine AMT. Please note the omnipresent and vague use of the word “certain”:
•Addition of personal exemptions,
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•Addition of the standard deduction (if claimed),
•Addition of itemized deductions claimed for state and local taxes, certain interest, most miscellaneous deductions, and part of medical expenses,
•Subtraction of any refund of state and local taxes included in gross income,
•Changes to accelerated depreciation of certain property,
•Difference between gain or loss on the sale of property reported for regular tax purposes and AMT purposes,
•Addition of certain income from incentive stock options,
•Change in certain passive activity loss deductions,
•Addition of certain depletion that is more than the adjusted basis of the property,
•Addition of part of the deduction for certain intangible drilling costs, and
•Addition of tax-exempt interest on certain private activity bonds.
IRS Form 6251, essentially a 54-line formula, is used to calculate the AMT for your tax return. Most tax software programs are designed to combine the variables to determine if a taxpayer must pay.
The most often cited problem with the Alternative Minimum Tax is that the exemption was not, until recently, adjusted for inflation. And so this tax, the intent of which was to bring wealthy individuals back into the fold by requiring that they also contribute financially to this great country, is now being inflicted on the middle class.
One has to question the effectiveness of the AMT. It came into being in 1969 due to public outcry that 155 individuals making more than $200,000 per year, 20 of whom were millionaires, paid no federal income tax whatsoever.
Obviously, it hasn’t helped to improve these conditions. In fact, things have gotten worse. According to a post on April 5 at www.whitehouse.gov 1,470 households making more than $1 million a year paid no federal income taxes. A startling 22,000 households that made more than $1 million in 2009 paid less than 15% of their income in income taxes according to the IRS. Note that the 15% tax rate was designed to cover incomes ranging from $8,500 to $69,000 depending upon filing status.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.