50th Year of AMT - Past Time to Repeal It

The alternative minimum tax (AMT) on individuals was created in 1969 - by the Tax Reform Act of 1969 (P.L. 91-172; 12/30/69). This problematic tax is about to reach its 50th anniversary at the end of the year. With the Tax Cuts and Jobs Act of 2017, the corporate AMT was repealed, it is time to repeal the individual AMT and deal with the reasons why it was enacted in a more equitable and logical manner.

Here is the description from the Joint Committee on Taxation's Summary of H.R. 13270, The Tax Reform Act of 1969 (8/18/69): "Limit on Tax Preferences.—In those cases where tax preferences are not fully subject to tax, provision is made for a minimum tax on individuals having tax preferences in excess of their taxable in- come. The additional tax in this case is determined by adding to the regular income subject to tax, one-half of the tax preferences but only to the extent they exceed the regular income."

The JCT report lists reasons for and against the minimum tax, as follows.

"Arguments For.—(1) The limit on tax preference is based on the premise that individuals generally should be required to pay tax on at least one-half of their economic income.
  (2) The limit on tax preferences has the advantage of making sure that individuals generally pay tax on a substantial part of their 48 income. It, therefore, serves as a second line of defense against the avoidance of income taxes, to back up the first line of defense against such avoidance offered by the remedial provisions in the House bill which limit the scope of specific tax preferences.
  (3) The bill corrects the unfair discrimination in present law which favors those taxpayers who derive their income from the ownership of property as contrasted with those who earn their living from wages and salaries.
  (4) The present law improperly encourages investment of capital in certain areas for tax consideration rather than good business reasons and violates the principle that taxes should have a neutral impact on economic decisions.
  (5) Many individuals with large incomes benefit from tax preferences to the extent that they pay lower average rates of effective tax than many individuals with moderate incomes. This makes a mockery of a tax system based on the ability to pay.

Arguments Against.—(1) This limitation is an imperfect substitute for direct action on the preferential income tax provisions which cause today's tax injustice. Each particular item of tax preference should be considered on its own merits and should be adjusted accordingly.
  (2) Enactment of a limit on tax preference complicates present law by imposing a new income tax system on top of our present system thereby compounding the complexity of the tax laws and adding considerable administrative difficulties to the existing system.
  (3) This new approach could become the forerunner of a gross receipts tax on all taxpayers.
  (4) The bill raises a constitutional question as to the power of Congress to tax income from State and local government obligations, particularly obligations already outstanding.
  (5) The bill is inadequate; the excess of percentage depletion over cost depletion and the excess of intangible drilling and development expenses over the deductions allowed under straight line depreciation should be added to the list of tax preference items subject to the limit on tax preferences.
  (6) The limit on tax preferences will discourage charitable gifts.
  (7) If Congress has seen fit to provide a specific tax benefit, there is no reason why it should be denied to some merely on the ground that it, in combination with other items, represents a large proportion of that individual's income.
  (8) Since this limit will not affect individuals until the sum of their tax preference income equals one-half of their total income, it will still be possible for some individuals to exclude substantial amounts of tax preference income from tax."

The Tax Reform Act of 1986 modified the minimum tax making it the alternative minimum tax. The goal remained mostly the same - to be sure high income individuals do not use a combination of deductions, exclusions and credits to reduce their tax liability below a perceived minimum level. While some of these items could have instead been repealed or scaled back, Congress believed each individually had merit.

The Tax Cuts and Jobs Act does cut back on some deductions which causes far fewer individuals to owe AMT. It is debatable whether the best items were cut back (such as with the $10,000 state and local tax deduction cap), with over 150 special provisions in the law, it seems more could be done to reduce tax preferences, particularly those used by a small number of higher income individuals such as the exclusion for tax-exempt interest income, the high mortgage interest deduction and the exclusion for employer-provided health care could be reduced for higher income individuals. These changes (and perhaps others) should be enough to allow repeal of the AMT

After all, shouldn't there just be one "minimum tax" - your regular tax calculation?  [Also see my 2007 op ed on this topic!]

What do you think?

Note: For more on the history of the AMT, see this 2016 CRS report, The Alternative Minimum Tax forIndividuals: In Brief.

Senate Finance Committee's New Approach to Tax Reform

The Senate Finance Committee recently announced that it will be holding weekly meetings to discuss various topics.  There will be "tax policy option papers" posted to their website that list a variety of reforms and their source.  This seems more for discussion purposes because they also note that just because a suggestion is included in an option paper doesn't mean it is endorsed the the Chair or Ranking Member.

The first paper posted is on Simplification for Families and Businesses.  Simplification is a good topic to start with. That is likely the most serious problem with our tax system.  The complexity stems, though, from both the rules themselves and transactions that can be complex (both for families and businesses). The simplification topics also include ones focused on administration of the tax laws. They note the following key problems areas regarding administration:

Some specific concerns about tax administration today include the following:

• Overall complexity
• Identity theft
• Tax gap
• Problems with the filing schedule
• Regulating paid return preparers 

Here are a few interesting reforms (I think) from the list and my commentary:

• Repeal AMT - yeah! This is not only simplification but brings some logic to the system. Why should there by two taxes - your actual one and your perceived minimum one?
• Repeal phase-outs for itemized deductions and personal exemptions - yeah! These phase-outs disguise a higher tax rate and make it difficult for affected individuals to know their marginal tax rate.
• Change due dates to enable taxpayers and IRS to get certain information earlier - yeah! It is difficult to file a return with missing K-1s. Also, former Commissioner Shulman's idea to have the IRS take the information returns and prepopulate returns for taxpayers so they know before they file (rather than a few years later) what 1099s and W-2s they have. Click here to see the AICPA proposal on this.
• If the IRS is not successful in its appeal in the Loving case on the paid return preperer system, provide a statutory solution - yeah!  I think there is value in having Circular 230 cover more than attorneys, CPAs and Enrolled Agents. Attorneys and CPAs are already subject to regulation by their licensing bodies.  Why have a system where about 50% of the preparers are not subject to rules of conduct regarding due diligence, return preparation standards, and more. While the preparers are subject to penalties, why not lay out some rules of conduct for them to help them avoid the penalties.
• Revoke or deny passports for individuals who are seriously delinquent - interesting.  If you want someone to do something, consider a carrot or a stick.  If the stick of penalties isn't working, why not deny them something they want. Of course, not everyone wants a passport.

Here are a few I think should be on the committee's list:

• Simplify depreciation rules.  Today, the rules on depreciation are scattered over at least 4 Code sections (167, 168, 179, 280F) and over 60 pages, not counting regulations. Depreciation should not be this difficult.  It is because of special rules, often designed to address some perceived abuse (such as the mid-quarter convention and the limitation on depreciation of passenger cars).  [I have a paper with some ideas on this topic.]
• Remove special rules where divorced parents can decide which parent claims a child as a dependent. Just leave it as going to the parent who has the child residing them with the majority of the time. If the parents want a different financial result, work it out through child support and alimony. The tax law is not intended to solve problems, but to raise revenue for government operations.
• Repeal the kiddie tax.  This is intended to address the situation where parents or someone else gives income-producing assets to a child who is in a lower tax bracket. Well, if it is a valid transfer of assets, let the child pay based on their rate bracket.  Also, if tax reform does result in broadening the base and lowering tax rates, this is not as significant of an issue.
• Repeal the uniform capitalization rules (Section 263A).  Doing so will enable manufacturers and retailers to use their book method for identifying inventoriable costs and save compliance costs due to not requiring a separate set of inventory records and calculations.

I have a few more, but would like to see what you have.  What would you do to simplify the income tax?

Challenges of lower tax rates for individuals

An October 11, 2012 letter from the Joint Committee on Taxation to Senator Baucus indicates that even significant tax law changes will not produce any sizable rate reduction.  The letter explains that if we were to:

• Make the EGTRRA and ARRA changes to EITC and child credit permanent
• Repeal the individual AMT
• nRepeal the limitation on itemized deductions and personal exemptions ("PEP" and "Pease")
• nRepeal all itemized deductions
• nTax capital gains and dividends as ordinary income
• nRepeal the exclusion for state and local bond interest for bonds issued after 2012
• nOffer no transitional relief

ThisThis would allow for a revenue neutral tax rate reduction of 4% to achieve the following bracket structure (rather than the 15% to 39.6% structure scheduled to return in 2013):

• n14.4%, 26.88%, 29.76%, 34.56% and 38.02% 

q

The baseline used to compute the above considered that the 2013 rates returned as scheduled, there was no AMT "patch" and the limitation on itemized deductions and personal exemptions exist. 

I think the small resulting tax rate reduction is due in part to the expense ("cost") of the AMT patch which is about $68 billion per year. So if there is no patch, repeal of all of the individual AMT is quite costly (so to pay for it, you can't reduce rates much).

But is still seems a bit surprising because the proposed changes would increase the rate on capital gains and eliminate itemized deductions. 

The JCT letter also includes several tables including how the estimated distributional effects.

What do you think?

Romney and Property Tax Deductions

La Jolla means "The Jewel." It is located 12 miles north of Downtown San Diego.

 The Los Angeles Times reports that Mitt and Ann Romney received a property tax readjustment downwards on a La Jolla (San Diego) home they purchased in 2008 for $12 million. Per the report, they now save about $109,000 annually in property taxes. [Robin Abcarian, "Romneys, caught in housing bust, got tax cut in La Jolla," 8/5/12]

Their 2010 tax return reports they paid $226K of real estate taxes (Schedule A). They also owed AMT so likely did not get any benefit of the taxes on their federal return. But without the AMT, the federal deduction for the property taxes would provide up to a 35% tax savings for the Romneys. I have asked the question before and will again, why should the income tax subsidize the expenses of this second home? (See 5/3/12 post.) 

Many people (including me) call for repeal of the AMT. That will cost over $70 billion per year. One way to pay for it would be to repeal the property tax deduction on second (and third and more) homes, as well as cap the deduction for a principal residence based on the median home value for the particular region, for example.

Some tax planning for the Romneys - take the $109K savings and donate it to the State of California. That deduction is also allowed for regular tax and AMT.  Which points out another revenue offset likely needed for when AMT is repealed, a limitation on the charitable contribution deduction. Perhaps only allowing deductions for donations that exceed some percentage of one's income.

What do you think?

Tax provisions that expired at 12/31/11 - what to do?

The National Taxpayer Advocate's mid-year report (pages 1 – 7) notes the number of taxpayers affected by the delays in knowing what happens to some key provisions that expired at the end of 2011. Several of these provisions have expired and been renewed in the past, so it is likely that will happen again, but if not done soon, the 2012 filing season will likely be delayed, as it was when this happened in late 2010.

Expired provision	Number of individuals affected (millions)
AMT "patch"	27
Election to deduct state sales tax rather than state income tax	11
Mortgage insurance deduction	4
Above-the-line deduction for K-12 teacher expenses	4
Deduction for qualified tuition and expenses	2

The NTA also notes that about 70,000 taxpayers claim the research tax credit that expired once again (I think it is the 14th time) at the end of 2011.

A few observations:

• There are extra costs of the delay. The IRS needs to prepare tax forms and program its computers for the 2012 filing season. Delays or having to do the exercise twice is costly. Also, taxpayers do not know if they should have paid more estimated taxes, or they may have paid estimated taxes they ultimately don't owe.
• Uncertainty can also be costly in changed business practices. For example, when a US company is deciding where to perform research, a temporary research credit in the US doesn't stack up well against permanent incentives in many other countries.
• Why are there so many temporary provisions (60 expired at the end of 2011)? Several appear to be permanent because they have been renewed for many years, but taxpayers can't consider them to exist unless extended. The budget process prevents making them permanent. That is, in a 10-year budget projection, if a special deduction or credit is made permanent, its cost for the entire 10 years is in the budget and needs a revenue offset. If instead, only one or two years in included, a smaller revenue offset is needed.

On 8/2/12, the Senate Finance Committee passed a bill to extend many of these provisions. Click here for the SFC's description of the legislation. Click here for the Joint Committee on Taxation's revenue estimate for the bill. The cost for one to two year extension of several items totals $205 billion. That includes $132 billion for a 2-year AMT patch and $14 billion for a 2-year extension of the research tax credit.

SFC voted to extend some that were intended to be temporary economic stimulus, such as the shorter built-in gain period for certain S corporations. Why?  SFC voted to extend some oddly inequitable provisions such allowing a 7-year recovery period for certain motorsports racing track facilities (rather than 15 years for land improvements or 39 years for real property).

Final observation – how did the AMT patch come to cost $66 billion a year? That isn't even cost of repeal. That is to just keep 27 million individuals from paying AMT for whom it was never intended to affect.

The Blue Book for the Tax Reform Act of 1986 estimated that the individual AMT would raise $334 million in 1991. If you apply inflation adjustments to that figure, it would be $564 million in 2012.  Yes, million, not billions!  The AMT is way out of control!  It is past time to repeal this oddity of the tax system. For more on that, read my 2007 Business Journal op ed on this topic – still timely (unfortunately).

What do you think about the provisions that expired at the end of 2011 and remain expired today?  Should all be extended?  If not what criteria would you use to determine which to drop and which to make permanent?

Reforms desired by businesses

Recently, the Kogod Tax Center at American University and Bloomberg BNA released the results of a survey where advisers of both small businesses (less than $10 million of gross receipts) and medium-large businesses were asked how they would rate 15 tax reform proposals. The result was that 7 had similar support from both groups. Per the Kogod website: "The findings provide strong evidence that any tax reform bill would have to contain these measures to win the support of businesses."

The seven reforms:

1. 100% expensing of assets
2. a lower tax rate for corporate and passthrough entities
3. reduced payroll taxes for employees
4. elimination of the estate tax
5. clarification of rules on worker classification
6. replace the income tax with a national sales tax or other consumption tax
7. a single, flat rate income tax

Looking at more details of the survey, the top reforms desired by small businesses are not listed above - repeal of the AMT which was tied with lower payroll taxes for employers. The top reform for medium-large businesses was 100% expensing of assets.

I encourage you to read the article on the survey, written by Dave Kautter, managing director of the Kogod Tax Center (and formerly a partner in the Ernst & Young National Tax Practice, and my boss a long time ago.)

Some observations I'd like to make:

• One possible way that has been suggested to pay for a lower corporate tax rate is to change from MACRS depreciation to Alternative Depreciation System (ADS) with longer lives and slower methods. I think this flies in the face of trying to make U.S. firms more competitive internationally (see my article on challenges of reaching a lower corporate tax rate - here). The Kogod/BNA survey indicates that businesses want to move in the other direction - immediate expensing of assets! How will this affect efforts to lower the corporate tax rate in a revenue neutral manner?
• Reform discussions and the realities of finding revenue offsets to extend the 2001/2003 tax cuts for everyone and lower the corporate tax rate likely means that while we might see a lower corporate tax rate in the near future, we will see higher taxes on high income individuals including on qualified dividends. This all makes it difficult to know the tax rate any business is truly taxed at. Why not move to a system where all businesses are taxed the same with elimination of double taxation in the process?
• Why do businesses want lower payroll taxes for employees?  What about future shortfalls in the Social Security Trust Fund and the increase in the number of retirees to workers?
• Replacing the income tax with a consumption tax would be a risky experiment. It also is contrary to international competitiveness in that other countries have a VAT and an income tax.

What do you think?

Process and Policy

Tax policy or tax system design should also consider the application and effects of process of enacting laws and administration of the laws. We've had some odd process things going on in 2010 that affect a few principles of tax policy including simplicity and equity.

What caught my attention on this is an August 6 press release from the Senate Finance Committee - "Committee Republicans Reiterate Call for Mark-up of Expiring Tax Relief." At first I thought they were talking about the 73 provisions that expired at the end of 2009 - many of which a majority of Congress wants to renew, such as the research tax credit. But, they are talking about some of the 2001/2003 tax cuts that they want to extend by the end of this year (after 7 years of knowing they were temporary). The announcements includes this statement of why action now is needed: "to bring some certainty of continued tax relief in a struggling economy."

What about the certainty that could have been used earlier this year or even the end of 2009 on the provisions that expired at the end of 2009 including the AMT patch?

While many people believe that many of the expired provisions and the AMT patch would be extended in 2010, the fact that they have not been means that taxpayers cannot consider them in calculating estimated tax payments and businesses cannot consider them in their income tax provisions on their financial statements. When they do get extended, taxpayers find they have paid too much estimated taxes - money they could have used for other purposes during 2010.

What is also puzzling is that the PAYGO legislation passed in February 2010 basically gave a free ride to the AMT patch and many of the 2001/2003 tax cuts that apply to those making under $250,000 (or $200,000 if not married). So Congress hasn't been delayed because of the challenge of finding ways to pay for the AMT patch and many of the expiring 2001/2003 tax cuts. So why the delay? Why the added complexity with respect to delaying the 2010 AMT patch?

[For a nice overview of the PAYGO legislation enacted in February 2010, see this White House/OMB website - here.]

For the provisions that expired at the end of 2009, it is past time to determine which should permanently expire and which should be extended or even made permanent. And, given the delay, Congress really needs to consider any extension as not to December 2010, but to December 2011 at a minimum so they don't have taxpayers rightfully asking in January 2011 what will happen to the provisions that expired at 12/31/10.

Here, it is not only the tax system design (such as flaws with the AMT itself), but also the process that is causing complexity and some inequities.

Troubling and odd.

AMT Must Go

This month the Congressional Budget Office (CBO) released a report on the individual alternative minimum tax (AMT). The report points out how the number of individuals subject to AMT will increase dramatically in 2010 unless another "patch" is passed to increase the 1986-level exemption amounts and other adjustments.

Per the report: "Taxpayers with AGI between $200,000 and $500,000 will continue to be hit the hardest by the AMT. More than 77 percent of those taxpayers had AMT liability in 2009, and that share will grow to 98 percent in 2010. Those affected can expect to pay an additional $10,700 in tax, on average."

In his blog, CBO Director Elmendorf notes: "About 4.5 million taxpayers were affected by the AMT in 2009. That number has been kept relatively small by annual modifications to the AMT rules, but the most recent modifications expired at the end of calendar year 2009. Consequently, about 27 million taxpayers—one out of every six taxpayers—will be affected by the AMT in 2010, paying on average an additional $3,900 in tax. Nearly every married taxpayer with income between $100,000 and $500,000 will owe some alternative tax."

Clearly the individual AMT is out of control. When the AMT was broadened by the Tax Reform Act of 1986, it was not done so to reach the middle class. But the failure to adjust the exemption amounts and rate brackets for inflation have caused the AMT to just become a penalty. Also, the addition of more favorable tax deductions and credits for individuals means the AMT is more likely to kick in.

I've written about the need to repeal this tax before. I'm not the only one that has called for its repeal. The Joint Committee on Taxation, the AICPA and ABA have done the same. There should be only one minimum tax - the one we currently call the regular tax. If Congress believes that deductions and credits are allowing people to pay less than the minimum, then be more transparent about it all and just reduce or eliminate some of these numerous tax breaks that also are a source of complexity in the law.

Here is my op ed from 2007 where I call it a disgrace and point out the policy reasons why it should be repealed - Simplicity and transparency versus the dread AMT, Silicon Valley/San Jose Business Journal. The repeal will be scored as a revenue loser which is unfortunate because it would be counting dollars that never were expected back in 1986. Given the purpose of the AMT to cut back on the aggregate effect of preferential deductions and credits, Congress should cut back directly on some of these items AND stop adding new ones without getting rid of old ones!

What do you think?

Temporary or Permanent - Which Is Better?

The Joint Committee on Taxation notes that 73 provisions in the federal tax law expire at 12/31/09 (JCX-20-09). These include:

• Personal tax credits allowable against AMT
• Increased personal exemption amount for AMT
• Additional standard deduction for state and local real property taxes
• Above-the-line deduction for qualified tuition and related expenses (§222)
• Exclusion of unemployment compensation benefits from gross income
• Refundable credit for government retirees
• Increased §179 expensing to $250,000/$800,000
• New markets tax credit
• R&D credit
• Add’l 50% first year depreciation
• Credit for construction of new energy efficient homes (§45L)
• FUTA surtax of 0.2 percent
• 65% subsidy for payment of COBRA health care coverage continuation premiums

While there have been numerous bills introduced that extend just one expiring provision, such as the research tax credit or the special deduction for teacher supplies, we only just yesterday, saw a bill that extends many of the provisions and is promoted as revenue neutral. That bill, H.R. 4213, introduced by House Ways & Means Chairman Rangel, is projected to cost about $30 billion but has offsets. The bill is 110 pages long! The offsets:

• Foreign Account Tax Compliance Act of 2009 (H.R. 3933 & S.1934)
• Tax carried interest as ordinary income

The bill also calls for the Joint Committee on Taxation to submit report on each extended provision by 11/30/10.

The bill does NOT include a "patch" for the individual AMT for 2010. If such a patch is not enacted, millions of individuals for whom the AMT was not intended, will owe it in 2010. It is likely that the patch will be enacted, but perhaps was omitted from H.R. 4213 due to the cost and the desire to get something passed by year end. Unfortunately, the longer it takes to enact the "patch" the more complicated taxes become for millions of individuals because they won't know what their estimated 2010 taxes will be.

Most of the extended provisions in H.R. 4213 are extended for just a year. Several have been extended many times before. So, this all begs the question - is it best to keep special rules in a temporary form so they DO get reviewed by Congress regularly or is it best to not waste the effort and problems of delayed extension and just make these provisions permanent?

The answer depends.

• Some of these temporary items were for stimulus and should not be extended unless it is clear they worked and stimulus is still needed.
• Any provision that has been extended more than 5 times should be seriously looked at to see if it should become a permanent provision. The research tax credit is a good example. Yet, since it is an incentive provision rather than a provision that defines "taxable income" it should still be reviewed regularly. But, moving it beyond repeated one-year lifes would enable the credit to be better utilized because businesses could better factor it into future R&D plans.
• Accountability measures should be created for new tax breaks and they should all likely start off as temporary. When a deduction or credit is permanently enacted, it becomes "off budget" in that Congress has no obligation to review it ever (unlike line item budget items). When new provisions are enacted as temporary measures, they need attention when the expiration date comes up. THE PROBLEM with our current federal system is that there is no accountability measure designed with new provisions that would ensure that Congress has DATA it can use to determine if the provision should be extended, modified or left to expire. States have similar problems, but some do enact accountability measures to ensure that they have DATA before it is time to consider renewal of the provision.

Here is an example of an accountability measure. The State of Washington’s reduced B&O tax rate incentive available to certain manufacturers of solar energy systems sunsets on 6/30/14. The enacting legislation included a requirement that by 12/1/13, the Department of Revenue provide the legislature with a report that notes the number of solar energy system manufacturers in Washington, the change in number, and the effect on job creation from the reduced tax rate. [Washington, SB 5111, Chapter 301, Laws of 2005 (7/1/05)]

So, Congress should include some type of data reporting mechanism for incentive provisions and they should be enacted on a temporary basis. Renewal should then depend on whether the incentive is having the intended effect. This would ensure that provisions are not extended just for expediency.

Provisions that are design features, such as the AMT patch (an inflation adjustment should have been part of the original provision), should be permanently enacted.

For more information on H.R. 4213:

• Ways & Means summary
• Text of the bill
• Joint Committee on Taxation revenue estimates (JCX-59-09)

What do you think?