Permanent AMT fix protects millions of middle-class taxpayers

Indexing exemptions to inflation ends need for future patches

Jan 6, 2013 @ 12:01 am

By Mary Beth Franklin

The patch ends here.

As part of the fiscal cliff negotiations, Congress agreed to boost the level of alternative-minimum-tax exemption retroactively for 2012 and to index future exemption levels to keep pace with inflation.

“We went all through 2012 not knowing whether an additional 26 million taxpayers would be affected by the AMT,” said Mark Luscombe, principal federal tax analyst for CCH, a division of Wolters Klewer Financial Services Inc. that provides tax and accounting software and services. “Making the AMT exemption permanent at least gives people some certainty going forward.”

Without congressional action, more than 30 million middle-income people would have had to pay the AMT in 2012, up from 4 million in 2011.

The tax was created in 1969 to make sure that the very wealthy paid at least some tax. But because it was never indexed to inflation, every year it has snared more and more middle-income taxpayers, morphing from a “class tax” into a “mass tax.”

In recent years, Congress has responded by approving temporary patches to boost the exemption level, often waiting until the last minute and sometimes delaying the start of the tax-filing season.

Jim Holtzman, a wealth manager and certified public accountant with Legend Financial Advisors Inc., said he was surprised and relieved that a permanent AMT fix was slipped into the fiscal cliff agreement.

But though the new higher exemption level will protect millions of taxpayers from being affected by the parallel tax system, he noted that the AMT still exists.

“If you've been paying it over the past five years or so, that won't change,” Mr. Holtzman said. “This patch does not exonerate you.”

Mike Robbins, director of tax practice at Rehmann Financial, a wealth management firm, agrees that a permanent fix to the AMT exemption levels is a step in the right direction and long overdue.

But it is just the first step, he said.

“The tax code still needs a comprehensive overhaul,” Mr. Robbins said.

Some lawmakers have proposed that the AMT be abolished altogether, but the AMT raked in more than $39 billion in revenue last year, an amount lawmakers might find hard to give up in times of massive budget deficits.

President Barack Obama has proposed replacing at least some of the lost revenue with the so-called Buffett Rule to ensure that taxpayers making more than $1 million a year pay an effective tax rate of at least 30%.

The AMT is a parallel tax system that disallows many of the deductions, exemptions and credits that taxpayers normally use to reduce their tax bills under regular rules. As a result, more income is taxed under the AMT.

Anyone subject to the tax must calculate their taxes under both sets of rules and pay the higher of the two.

No single item triggers the AMT, but several factors make some taxpayers more vulnerable to the onerous tax, including income above $100,000, many itemized deductions, a large number of personal exemptions and exercising incentive stock options.

For example, if a married couple with three children were subject to the AMT in 2012, they lost $19,000 ($3,800 x 5) in personal exemptions, possibly boosting their federal tax bill by hundreds or even thousands of dollars per year.

And because deductions for real estate taxes and state and local income taxes aren't allowed under the AMT, residents of high-tax states such as California, New Jersey and New York are more likely to pay the AMT than residents of lower-tax states.

In addition, those who exercise incentive stock options but don't sell them the same year may be snagged by the AMT. Although the paper profit isn't taxable under regular tax rules, the AMT treats the difference between the exercise price and the market value on the day of the exercise as a taxable event.

But the wealthy — the original target of the AMT — often escape the onerous tax. The top AMT tax rate is 28%, lower than the top tax bracket under the regular tax code, meaning that the wealthy can claim more deductions than lower-income taxpayers who have to forfeit many of their tax breaks under the AMT.

HIGHER EXEMPTIONS

The fiscal cliff deal raises the AMT exemption amounts for 2012 to $50,600 for single individuals and $78,750 for married taxpayers filing jointly. Without the permanent fix, the 2012 exemptions would have reverted to the 1993 levels of $33,750 for individuals and $45,000 for married couples filing jointly.

The 2013 AMT exemption amounts are projected to be $51,900 for single individuals and $80,750 for married couples filing jointly.

Not only will the permanent fix shield millions of middle-income taxpayers from paying the AMT on their 2012 returns, it will also improve tax-planning opportunities for 2013, said Scott Cheslowitz, a certified public accountant with Rothenberg & Peters PLLC.

“It's friendly to tax practitioners, for sure,” said Mr. Cheslowitz, who serves as a member of the rapid- response team for the New York State Society of CPAs. “It gives us more certainty as to what our tax planning can achieve, as opposed to forcing us to weigh conflicting hypothetical scenarios about accelerating or postponing income and expenses.”

The fix also means a speedier start for the tax-filing season.

Acting Internal Revenue Service Commissioner Steven Miller estimated that 80 to 100 million taxpayers would have experienced a delay in filing their 2012 returns if Congress had failed to enact an AMT patch in time.

mbfranklin@investmentnews.com Twitter: @mbfretirepro

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