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CRS Updates Report on AMT Entry Points and 'Take Back' Effects

DEC. 14, 2006

RS21817

DATED DEC. 14, 2006
DOCUMENT ATTRIBUTES
  • Authors
    Esenwein, Gregg A.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2007-711
  • Tax Analysts Electronic Citation
    2007 TNT 7-36
Citations: RS21817

 

Gregg Esenwein

 

Specialist in Public Finance

 

Government and Finance Division

 

 

Summary

 

_____________________________________________________________________

 

 

The alternative minimum tax for individuals (AMT) was originally enacted to ensure that high-income taxpayers paid a fair share of the federal income tax. However, the recent reductions in regular income taxes coupled with the lack of indexation of the AMT has greatly expanded the potential impact of this tax.

Temporary increases in the AMT exemption amounts are scheduled to expire at the end of 2006. If this occurs, then the number of taxpayers subject to the AMT will jump from 3.5 million in 2006 to 23 million in 2007. Taxpayers filing joint returns with no dependents will be subject to the AMT starting at income levels of $75,386. Large families will be subject to the AMT at income levels as low as $49,438.

In addition, for many taxpayers, the AMT will "take back" much of the recent reductions in the regular income tax.

Fixing the AMT will be expensive. Assuming the recent reductions in the regular individual income are extended past 2010, repeal of the AMT would reduce federal tax revenues by over $1.4 trillion between 2007 and 2016. Projections indicate that it will soon be less expensive to repeal the regular income tax than to repeal the AMT.

This report will be updated as legislative action warrants.

_____________________________________________________________________

 

 

The alternative minimum tax for individuals (AMT) was originally designed to prevent a small number of high-income taxpayers from escaping their "fair" share of income taxes through the use of special preferences under the regular income tax.1 In the absence of legislative action, however, the number of taxpayers falling under the AMT is going to increase dramatically over the next few years.

There are two main reasons for the increase in the number of taxpayers affected by the AMT. First, recent tax reductions under the regular income tax have significantly narrowed the differences between regular and AMT tax liabilities. These tax reductions in the regular income tax occurred in the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16; EGTRRA), the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27; JGTRRA), and the Working Families Tax Relief Act of 2004 (P.L. 108-311; WFTRA). In addition to reducing taxes under the regular income tax, all of these measures contained temporary increases in the AMT exemption designed to mitigate the interaction between the reductions in the regular income tax and the AMT. The temporary increases in the AMT exemptions, however, expire at the end of 2006.

Second, the regular income tax is indexed for inflation but the AMT is not. Over time this has further reduced the differences between regular income tax liabilities and AMT liabilities at any given nominal income level, differences that will continue to shrink in the absence of AMT indexation.

The combination of these two factors -- reductions in the regular income tax and the lack of AMT indexation -- means that, absent legislative changes, there will be a significant growth in the number of taxpayers affected by the AMT.2 It is estimated that in 2006, about 3.5 million taxpayers will pay the AMT. If the temporary AMT exemption increase is not extended beyond 2006, then about 23.4 million taxpayers will pay the AMT in 2007. By 2016, if the EGTRRA/JGTRRA/WFTRA tax cuts are extended, then the number of taxpayers paying the AMT will increase to almost 50 million.3

Calculating AMT Liabilities

Under current law, to calculate AMT tax liability an individual first adds back various tax items (called adjustments and preferences) to his regular taxable income. The three major preference items added back to the AMT tax base are personal exemptions, state and local tax deductions, and miscellaneous itemized deductions. These three items account for over 90% of the total AMT preference items and adjustments that are added back to regular taxable income for AMT purposes. Other items subject to tax under the AMT include net operating losses, passive activity losses, incentive stock options, and private activity bond interest.

This grossed up income becomes the tax base for the AMT. An exemption of $62,550 for joint returns and $42,500 for single and head of household returns is subtracted to obtain AMT taxable income. (These exemption levels are temporary and are scheduled to revert in 2007 to their prior law levels of $45,000 for joint returns and $35,750 for unmarried taxpayers.) The basic AMT exemption is phased out for taxpayers with high levels of AMT income. A two-tiered rate structure of 26% and 28% is assessed against AMT taxable income. The tax is 26% of AMT taxable income up to $175,000 and 28% of AMT taxable income in excess of $175,000. The taxpayer compares his AMT tax liability to his regular tax liability and pays the greater of the two.

Structural Overlap of the AMT with the Regular Income Tax

The reductions in the regular income tax and the lack of AMT indexation means that in 2007 when the temporary increases in the AMT exemption expire there will be a structural overlap between the AMT and the regular income tax. Over certain income intervals, individuals will be subject to the AMT rather than the regular income tax.

Table 1 below shows the income levels at which joint returns with up to six children would be subject to the AMT rather than the regular income tax in 2007. That is, it shows the income intervals at which the AMT for these returns would be higher than their regular income taxes and, and as a result, they would pay the AMT. The table assumes that families use the standard deduction under the regular income tax and have no AMT preferences or adjustments other than their personal exemptions.4

For example, in 2007 taxpayers filing joint returns with two children and incomes between $66,114 and $423,200 will be subject to the AMT rather than the regular income tax. For larger families, the AMT will overlap the regular income tax at lower incomes and extend through higher incomes. For families with six children, the AMT supercedes the regular income tax for joint returns with incomes between $49,438 and $445,850.

  Table 1. 2007 Income Boundaries Where Joint Taxpayers Will Be Subject to the

 

                     AMT Rather than the Regular Income Tax

 

 

                                    Number of Children

 

            None       1         2         3         4         5         6

 

 

 Entry    $75,386   $70,750   $66,114   $61,477   $56,841   $52,205   $49,438

 

 point

 

 

 Exit    $411,890  $417,550  $423,200  $428,850  $434,510  $440,180  $445,850

 

 point

 

 

 Note: Calculated by CRS. Assumes income is all earned income, the use

 

 of the standard deduction, and that the families have no AMT preference items

 

 other than their personal exemptions.

 

 

"Take Back" Effect of the AMT

Table 2 shows the "take back" effect of the AMT in 2007. That is, the table shows how much of the EGTRRA/JGTRRA/WFTRA tax cuts will be lost if the AMT exemption amount for joint returns reverts back to $45,000 in 2007. For example, consider the case of a joint return with two children and an income of $70,000. If the EGTRRA/JGTRAA tax cuts had not been enacted, then their regular income tax liability in 2007 would have been $6,118. Their AMT tax liability in 2007 under current law will be $4,500. Since their AMT would be less than their regular income tax liability, they would pay their regular income tax of $6,118.

However, under current law (which includes the effects of the tax cuts) this family's regular income tax liability in 2007 will be $4,073. This represents a $2,045 reduction in their regular income tax compared to what it would have been under pre-2001 tax law. However, their AMT liability in 2007 will still be $4,500. Since their AMT liability is higher than their regular income tax, they would pay the AMT of $4,500. In essence, the AMT takes back $427 of the EGTRRA/JGTRAA/WFTRA tax reductions (the difference between the family's regular income tax liability, $4,073, and their $4,500 AMT liability). So, 21% of the reduction in their regular income taxes will be lost to the AMT ($427 in realized tax reductions divided by $2,045 in potential tax reductions).

   Table 2. "Take Back" Effect of AMT in 2007 on Recent Tax Cuts for Married

 

                  Couples with Two Children Under 17 Years Old

 

 

           Income Taxes       Income       AMT       AMT Take    Percentage

 

   2007    Assuming Pre-      Taxes       under      Back of     of Tax Cut

 

  Income   2001 Tax Law      Assuming    Current   Enacted Tax    Lost to

 

  Levels   (Pre-tax Cut)    Current Law    Law         Cuts         AMT

 

 

  $70,000      $6,118          $4,073     $4,500        $427        21%

 

  $80,000      $8,177          $5,573     $7,100      $1,527        59%

 

 $100,000     $13,777          $9,773    $12,300      $2,527        63%

 

 $150,000     $28,777         $24,273    $27,300      $3,027        67%

 

 $200,000     $44,247         $38,189    $40,300      $2,111        35%

 

 

 Note: Calculated by CRS. Assumes earned income, use of standard

 

 deduction, and that the only personal tax credits claimed are the child tax

 

 credit.

 

 

In percentage terms, the take back increases as income increases through $150,000 and then starts to decrease at higher levels of income. In these examples the hardest hit family has a $150,000 income. Under pre-tax-cut law, their income tax in 2007 would have been $28,777. With the tax cuts, their regular income tax will fall to $24,273, a reduction of $4,504. However, the AMT effectively takes back $3,027 of the cut in their regular income taxes, a 67% reduction.

Revenue Costs of Fixing the AMT

The revenue costs of fixing the AMT are substantial. It is estimated that the AMT will raise almost $70 billion in revenue in 2007. By 2010, it will bring in $117 billion in revenue. The Treasury Department projects that by 2013, it would be less expensive to repeal the regular income tax than it would be to repeal the AMT. Other analysts predict that the crossover point will come much sooner.5

Outright repeal of the AMT would be expensive. Estimates indicate that repeal of the AMT would reduce federal tax revenues by over $806 billion from 2007 through 2016, assuming the EGTRRA/JGTRRA tax cuts expire as scheduled in 2010. If these tax cuts are extended, then the cost of AMT repeal could rise to well over $1.4 trillion over the same period.6

Other less costly options include allowing state and local tax deductions against the the AMT, and extending/indexing the recent increase in the AMT exemption. As shown in Table 3, however, even these options are relatively expensive. For instance, allowing state and local tax deductions against the AMT would cost $222 billion between FY2007 and FY2011. Extending and indexing the recent increase in the AMT exemption would reduce federal revenues by $259 billion over the same period.

                      Table 3. Costs of AMT Modifications

 

                             (billions of Dollars)

 

 

                          2007      2008      2009      2010      2011

 

 

 Allow State and Local

 

 Tax Deduction Against   -25.1     -43.9     -50.3     -56.5     -46.8

 

 AMTa (fiscal years)

 

 

 Extend Increased AMT

 

 Exemption with           -4       -65       -60       -71       -59

 

 Indexationb (fiscal

 

 years)

 

 

 Repeal the AMTc

 

 (calendar years)        -69.8     -86.3     -97.6    -117.4     -49.4

 

 

 Assumes 2001/2003 tax cuts expire at the end of calender year 2010.

 

 

                              FOOTNOTES TO TABLE 3

 

 

      a Urban-Brookings Tax Policy Center. Table T06-0249, Oct.

 

 2006.

 

 

      b Congressional Budget Office. The Budget and Economic

 

 Outlook: An Update, Aug. 2006, p. 19.

 

 

      c Urban-Brookings Tax Policy Center. The Individual

 

 Alternative Minimum Tax: Historical Data and Projections, Nov. 2006, p. 8.

 

END OF FOOTNOTES TO TABLE 3

 

 

If the recent reductions in the regular income tax are extended beyond their scheduled sunset date of 2010, then the costs of each of the three AMT modifications shown in the table above would grow considerably. For instance, CBO estimates that if the tax cuts are extended, then the cost of extending and indexing the increased AMT exemption combined with allowing all personal tax credits against the AMT would exceed $1 trillion over the FY2007 through FY2016 period (including the increased debt service payments if the change is financed through an increase in the deficit).

 

FOOTNOTES

 

 

1 For a detailed history and explanation of the AMT see CRS Report RL30149, The Alternative Minimum Tax for Individuals, by Gregg Esenwein.

2 In addition, even though a taxpayer may not actually pay the AMT, it can still affect his tax liability because certain non-refundable tax credits under the regular income tax are limited to the excess of regular income tax liability over AMT liability. Temporary provisions which allow taxpayers to use personal tax credits against both their regular and AMT liabilities expire at the end of 2006. The child tax credit, the adoption tax credit, and the IRA contribution credit, however, can all be applied against both the regular income tax and the AMT.

3 Urban-Brookings Tax Policy Center. The Individual Alternative Minimum Tax: Historical Data and Projections, Nov. 2006.

4 Families with large amounts of AMT preference items in addition to their personal exemptions might face income entry points for the AMT that are lower than those shown in Table 1.

5 See, for example, Urban Brookings Tax Policy Center. Key Points on the Alternative Minimum Tax, Jan. 21, 2004.

6 Urban-Brookings Tax Policy Center. The Individual Alternative Minimum Tax: Historical Data and Projections, Nov. 2006.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Esenwein, Gregg A.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2007-711
  • Tax Analysts Electronic Citation
    2007 TNT 7-36
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