Alternative Minimum Tax (AMT) Patch in 2009 Recovery Act

The Alternative Minimum Tax (AMT), which began back in 1969, is a parallel tax system that was created to make sure taxpayers in the highest tax brackets weren't able to skip through the tax system. But because of a lack of adjustment over the years, this tax now reaches far deeper than the 155 individuals it was targeted at back in 1969. It is estimated that if changes are not made, it will expose 30 million taxpaers in 2010. Instead of comprehensively dealing with this, it appears we are now stuck in a year-to-year patch that doesn't really address the overall issue of the AMT.

So, what is it? The Alternative Minimum Tax is a tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT tax rate of 26% or 28%. The Alternative Minimum Tax (AMT) is the amount by which the tentative minimum tax exceeds the regular income tax.

In 2008, the AMT patch passed last year created an exemption of $46,200 for unmarried individuals; $69,950 for married couples filing jointly and surviving spouses; and $34,975 for marrieds filing separately. The Recovery Act of 2009 being considered no will "patch" AMT for another year (otherwise the AMT exemption amounts would decrease to much lower year 2000 levels). The Recovery Act makes no change in the AMT phaseout rules.

So for 2009, the AMT exemption amounts for individuals are: married individuals filing jointly and surviving spouses, $70,950, less 25% of alternative minimum taxable income (AMTI) exceeding $150,000 with zero exemption being reached when AMTI is $433,800; unmarried individuals, $46,700, less 25% of AMTI exceeding $112,500 (zero exemption when AMTI is $299,300); and married individuals filing separately, $35,475 less 25% of AMTI exceeding $75,000 (zero exemption when AMTI is $216,900).

Absent any permanent fix by Congress, the 2010 AMT exemption amounts for taxpayers will revert to the levels they were at for 2000. The one-year Recovery Act AMT “patch” has the effect of postponing, for yet another one year period, the exemption reductions that were scheduled to go into effect for 2009. Unless something substantial is done, 30,000,000 taxpayers and nearly every married couple making more than $75,000 will find themselves subject to the AMT in 2010. This sure is a far cry from the original intent of capturing 151 individuals who made over $200,000 in 1969 - the inflation-adjusted equivalent of $1,157,629 in 2008.

AMT Filers May Finally Get Some Needed Relief

The IRS has announced that it will suspend the collection of back taxes from tax filers that have a large AMT liability due to the sale of Incentive Stock Options. Congress is FINALLY working to approve legislation that would help taxpayers who exercised ISOs during the "Dot com" boom and subsequent bust cycle of 2000 and 2001.

Let's take an example to show this point. As part of his incentive package, a mid-level manager of Yahoo receives an option to purchase 1,000 shares of the company at a strike price of $40 a share back in 1999. Quickly, the stock rises and goes over $100 a share by the beginning of 2000. The employee decides to purchase his options at $40. But - rather than immediately sell the stock - he decides to hold on to the 1,000 shares.

Since the stock options are an Incentive Stock Option, the employee has to recognize the unrealized gain on the difference between the option price and the market price at the time the shares were optioned. This means that this mid-level manager now has to pay tax on the $60,000 gain ($100,000 value versus his actual cost of $40,000) - even though he has not sold the stock. Why? The ISO purchase places him in the Alternative Minimum Tax category. Not only that, but Mr. Yahoo Manager isn't eligible for the 15% long-term capital gains rate. He now has to pay 26% of income (or 28% - depending on his income). To make matters worse, this poor fella hasn't even sold the stock yet. He decided to keep it. So, he has to find the cash from other savings to pay the tax. Sound like a disincentive to hold company stock as an investment?

Being a dedicated employee, he hangs on to his stock while watching it fall off its high in January 2000. He becomes anxious but knows the stock will come back. So, when his tax bill comes due on April of 2001 - and this Yahoo employee realizes his tax bill - he realizes he now has to sell the shares to pay the tax. But there's a problem. The stock has declined to $10 a share! This AMT tax filer has watched his stock get decimated and now doesn't even have enough net proceeds from the sale to pay his Alternative Minimum Tax!

Under the provisions of what Congress is attempting to pass, taxpayers that were caught in this unfortunate predicament will not get their AMT completely relieved. However, they will be able to speed up the use of the AMT credits that were generated as a result of these transactions. This, in effect, will provide a "relief" of sorts on subsequent tax bills. Thus, the IRS has decided to hold off on collecting these back taxes until the AMT credit can be recognized.

Shared Tax Burden? Spread The Wealth

According to the most recent data from the IRS, the top 1% of filers are now bearing a record share of the income tax burden. In 2006, people with an adjusted gross income of more than $388,800 paid 39.9% of all federal income taxes while earning just 22% of the overall income. This is up from the 2005 data which showed the top "one-percenters" paying 39.4%.

The top 10% - which includes you if you earn more than $108,900 - pull in 47% of adjusted gross income but pay almost 71% of the total tax burden. The culprit? perhaps it is the Alternative Minimum Tax. In 2006, an estimated 3.8 million taxpayers were affected by the AMT and by 2007 that number is expected to grow to 23 million taxpayers.

It certainly doesn't appear that anyone has increased the number of tax breaks to the "wealthy". With record deficits and talk of increasing taxes, the only thing that appears to be increasing is their share of the overall tax burden.

On final interesting thing to note. The bottom 50% pay roughly 3% of the total income tax bill and the lowest income earners actually have a NEGATIVE income tax. Since their income is low enough to get the earned income credit, they qualify to get a refund on income AND payroll taxes.

Alternative Minimum Tax, Capital Gains and the Time Value of Money

There are rumors floating around out in cyberspace that Congress will take a hard look at creating a more permanent fix for the Alternative Minimum Tax. More than a few are suggesting the possibility of increasing the capital gains tax rate back to 20% to offset the AMT fix. We've seen talk of these rumors recently begin to kept many from completing exchanges. I've actually heard people say it is better to pay 15% now versus the potential to pay a 20% capital tax rate at some later date. (Most of the time this statement comes right after the other assumed imminence of "when the Democrats take power back".) For that reason alone, some are deciding to NOT complete a 1031 exchange.

While that thinking seems to save 5% in taxes, it also ignores the fact that time and inflation affects the value of money. The time value of the 15% tax money paid today versus the eventual higher (presumed) 20% taxable sale may or may not save the taxpayer. It depends on when that transaction might occur. Follow me?

Consider a scenario where the 15% long-term tax paid would instead be reinvested (we'll even ignore the additional state tax paid). In other words, rather than paying Uncle Sam today, the money is reinvested, via a 1031 exchange, into investment property. Let's assume that this taxpayer is planning on reinvesting the funds and planning to hold the replacement property for ten years. At that time, the taxpayer plans on selling the property and paying the taxes (ten years from now). We'll also assume the reinvested money will conservatively earn a inflation-free rate of 4% a year. In other words, if inflation runs 3%, the investment will earn 7%. (Just to make the analysis even more conservative, we'll even ignore the ability to leverage that tax-free, reinvested money into an even larger investment).

So what is the present value of that 15% in taxes paid ten years from now? To figure this out, let's illustrate what the two scenarios have. If you pay the tax on a $100 capital gain today, you get $85, right? But if you take the $100 and reinvest it for 10 years and earn 4%, after inflation, each year, you'll have $149 in today's dollars (you'll actually have much more if you assume some inflation). So, you then turn around and pay 20% capital gains tax on $149 - winding up with $119 - versus the $85 you'd have today if you paid the lower tax today.

So why again, if you are planning on reinvesting the funds anyway, would you pay the 15% today versus the 20% ten years from now? And let's not mention there is typically a state capital gains tax or talk about the uncertainty that five or ten years from now, the capital gains tax rate will not be, again, changed/reduced.

AMT patch without revenue offsets

Last week the House approved the Senate-passed version of the "Tax Increase Prevention Act of 2007". President Bush is expected to sign the Act. It provides for a one-year patch of the AMT for 2007 but does not offset the revenue cost of the measure with revenue raising provisions.

Under the Act, the AMT exemption amounts for 2007 for individuals will increase from $66,250 for married individuals filing jointly and surviving spouses, up from $62,550 for 2006, $44,350 for unmarried individuals, up from $42,500 for 2006; and $33,125 for married individuals filing separately,up from $31,275 for 2006. It also allows the sum of personal nonrefundable credits (dependent care credit, elderly and permanently disabled credit, mortgage credit, etc) may offset both regular tax and AMT.

Keep in mind, this is only a temporary fix. Congress will still need to address the AMT exemption and the allowance to offset AMT taxes with credits during the 2008 session or the exemptions figures will revert back to the levels set in 2000 ($45,000, $33,750 and $22,500, respectively) and the offsets will go away.

So will they? It probably depends on your political viewpoint and whether they will fix what is sure to a problem for a growing number of taxpayers. One thing can be said, 2007 will result in less tax revenue as a result of the changes and some that were scheduled to creep into AMT will now stay out of this progressive tax. Unique to the passage of this Act is that it didn't involve increasing revenue or offsetting the lower tax with higher taxes in another area. It is widely runoreed that a more permanent fix to the AMT system would have to involve a higher capital gain tax rate - roughly back a 20% long-term rate.