02/ 11/ 2008
by Shannon McRae
The best intentions don't always produce the best results, and the alternative minimum tax is a shining example. The tax seemed like a good idea when it was established in 1969 to prevent a handful of extremely wealthy Americans from using unfair advantages to evade their fair share of taxes. But in the four decades since the AMT was enacted, its reach has crept from the very wealthy to average, middle-class American taxpayers--many of whom are small-business owners.
The AMT has evolved into a tax system that is parallel to the country's regular income-tax system. Those affected by the AMT are forced to calculate their taxes twice, and then pay the higher amount. Because of the way most small businesses are structured, many small-business owners file as individuals. While they may realize savings and deductions under the regular tax code, they face different scenarios under the AMT. Instead, it increases your taxable income base by adding back items that were exempt under the regular tax system and disallowing deductions and credits.
Since 1998, Congress has passed several temporary "patches" to the AMT that reduce the number of taxpayers affected by raising the exemption amount.
If it all sounds complicated--it is, which is why 75 percent of taxpayers affected by the AMT hire professionals to prepare their returns, according to a report from the President's Advisory Panel on Tax Reform.
Roy and Edith Quick help many small-business clients who are affected by the AMT. The husband-and-wife team, who own St. Louis-based Quick Tax Accounting Services, are accustomed to clients having questions about the confusing tax. "There's no one on the face of the earth who truly understands the AMT--including the IRS," Edith says. "It's a real rat hole."
When the Quicks started their business in 1984, the AMT was still an obscure tax. But two years ago, the AMT's reach had grown so much that the Quicks decided to run the AMT schedule on every client's tax return. "You just never know who will be affected," Roy says. "There are so many varying factors."
The AMT affects more taxpayers each year because lawmakers failed to index the tax to inflation when it was created. The personal exemption, standard deduction and rate brackets are all indexed to inflation, so tax rates don't rise when income keeps pace with inflation. But because the AMT is not indexed, more and more middle-income taxpayers--those who were never supposed to be affected--have consequently owed additional taxes. The Congressional Research Service estimates that 4 million Americans were subject to the tax in 2007. If Congress doesn't change the current rules, 70 percent of taxpayers will be affected by 2050, according to the Congressional Budget Office--a far greater number than the handful of wealthy Americans who initially sparked the law's creation.
The simple solution would be for Congress to repeal the AMT, but that's not a viable option for such a lucrative tax. Repealing the AMT would cost the United States almost $1 trillion over the next 10 years, according to the Congressional Joint Committee on Taxation. In addition, pay-go rules enacted by the current Congress prohibit any spending increases or tax cuts that aren't fully funded. So in order to repeal the AMT, Congress would have to cut spending or raise taxes by nearly $1 trillion--which is unlikely to happen.
Tax Talk in Washington
Complicating the AMT debate are the pending tax changes that will take effect after 2010, when lower individual tax rates, the estate tax and increased Section 179 expensing limits all expire. These upcoming changes coupled with the growing frustration over the creeping AMT are good indicators that Congress will have to consider substantial tax reform in the near future.
NFIB has taken a lead role in representing America's entrepreneurs in the ongoing tax debate in Washington, D.C. That's because NFIB members consistently rank federal taxes on business income as one the top five biggest challenges to running a business, according to NFIB's Problems and Priorities survey.
"Small firms with fewer than 500 employees represent 99.9 percent of the 26.8 million businesses in the country--both large and small," says NFIB President and CEO Todd Stottlemyer. "If America's small businesses were a separate economy, it would be the world's third-largest, trailing only the United States as a whole and Japan. NFIB is here to make sure that Congress does what it needs to do to ensure that this critical portion of our economy stays healthy and continues to grow."
As the tax debate gears up in Washington, New York Rep. Charlie Rangel, head of the House Ways and Means Committee (which has jurisdiction over the tax code), recently introduced a bill that would repeal the AMT and reform the tax code. The bill pays for the AMT repeal by adding a 4 percent surtax on adjusted gross income of more than $150,000 for individuals and $200,000 for married couples filing jointly. NFIB applauds Rep. Rangel's plan for making the increased Section 179 expensing limits permanent, but the bill does not address the estate tax or the lower individual rates, which are both set to expire in 2010.
Large corporations would benefit greatly from Rangel's proposal, which reduces the corporate tax rate from 35 percent to 30.5 percent. However, the plan doesn't offer the same relief to businesses that file as S-corporations, which pay the same tax rates as individuals. "Tax relief for small entrepreneurs is just as vital to our economy and America's competitiveness as relief for large corporations," Stottlemyer says.
In addition to Rep. Rangel's bill, a group of conservative House members who comprise the Republican Study Committee introduced a bill aimed at eliminating the AMT and providing taxpayers the alternative of a flat-tax rate of 10 percent or 25 percent. Under this plan, taxpayers would have the choice of paying taxes under the existing code or opting for the flat-tax rate instead. Supporters of the plan point to its simplicity and transparency.
"Regardless of any plan's specific details, small-business owners want to see real reform of the nation's tax system," Stottlemyer says. "As it stands, our nation's largest job creators spend millions of dollars and countless hours to comply with the tax code. Imagine the opportunities for America's economy if those owners spent that time and money growing their businesses instead."
AMT Update
On Dec. 26, President Bush signed a one-year AMT patch into law. The bill, which the House passed by a vote of 352–64 and the Senate passed by 88–5, increases the AMT exemption amount to $66,250 for joint filers and $44,350 for single filers, ensuring that no additional taxpayers are liable for the AMT this year. NFIB is pleased that Congress passed this important tax relief without tax increases. We believe that since the AMT was never intended to apply to middle-income taxpayers, the revenue raised was also unintended and should not be recovered by raising other taxes.
Since this patch applies only to this tax season, Congress will have to address this issue again in 2008.
Minimize Your AMT Exposure
There are a few things you can do to curb your AMT liability:
Accelerate income. Since individuals face a flat 26 percent or 28 percent rate under the AMT, accelerating income while the overall rate is lower can help minimize your taxes. Here are a few ways to do that:
- Take a prepayment of salary or bonuses.
- Recognize short-term gains on portfolio securities.
- Redeem Series EE U.S. savings bonds or certificates of deposit.
- Withdraw money from your IRA or other retirement funds.
- Convert tax-free bonds to higher-yielding taxable bonds.
- Defer disallowed AMT deductions:
- Defer making your estimated state income-tax payments until the next year.
- Defer paying your real estate or personal property taxes until the next year.
- Defer any medical expenses that don't total 10 percent of your adjusted gross income.
- Defer payment of any employee business expense, union dues, job education, investment and tax-preparation expenses.
- Depreciate rather than deduct business furniture and equipment.
The Current Debate
A look at how some recently introduced plans stack up for small-business owners.
Rep. Charlie Rangel's proposal would repeal the AMT and reform the tax code. Some key provisions in his plan include:
- Paying for AMT repeal by adding a 4 percent tax surcharge on adjusted gross income over $150,000 for individuals and $200,000 for married couples filing jointly.
- Making increased Section 179 expensing limits permanent.
- Reducing the corporate tax rate from 35 percent to 30.5 percent, which does nothing to address concerns for S-corporation business owners, many of whom file as individuals.
Rangel's plan doesn't address the estate tax or the lowered individual rates, both of which are set to expire in the near future.
The Taxpayer Choice Act, developed by the Republican Study Committee, would repeal the AMT and provide taxpayers with an alternative flat-tax system. Some key provisions in this plan include:
- Offering taxpayers a choice of paying taxes under the current tax code or switching to the new simplified code that has just two income tax rates--10 percent and 25 percent. The percentage is based on income levels. Individuals pay 10 percent on the first $50,000 of their taxable income ($100,000 for joint filers). Individuals could choose to pay taxes under the new system some time within 10 years of its enactment. After the initial choice, individuals would be allowed one additional change between the two systems during their life, other than for major events such as death, marriage or divorce.
- Eliminating what the group estimates to be an $841 billion tax increase that would result from the automatic expansion of the AMT or other taxes proposed to "offset" the AMT.
- Making capital gains and dividend tax relief of 2003 permanent.
The U.S. Senate has taken up the debate as well. Sen. Max Baucus, D-Mont., plans to hold a series of hearings in the Senate Finance Committee during 2008 on tax reform, and the AMT is likely to be a part of this debate. Separately, he introduced a bill in 2007 that would repeal the AMT. The Senate Republicans have also introduced a bill that repeals the AMT, and they have been major opponents of raising taxes to pay for the cost of the AMT.
Review the candidates' stances on taxes with this easy-to-print PDF (92 KB, PDF)
