Basis Points: A View From the Hills

AMT – The Other Flat Tax

September 2016

AMT – The Other Flat Tax

by admin on September 12, 2016

Steve Forbes ran for the Republican nomination for President in 1996. While not a true single issue candidate, Forbes platform was concentrated on the central issue of scrapping the existing internal revenue code and replacing it with a flat tax of 17%. Forbes was unable to garner significant support in either of his runs for the presidency, despite winning a couple of states here and there. The idea of a flat tax has yet to fully exit political discourse, but as deficits have widened and new Medicare and investment taxes have been implemented the chance of a flat tax seems more remote than ever.

The Stealthy “Flat” Tax

The cornerstone of the 1969 Tax Reform Act was the creation of the Alternative Minimum Tax (AMT). The goal of the AMT was to force wealthy taxpayers with huge income and deductions to pay some income tax by creating an alternate tax system that operated in the background, alongside regular income tax computations.
The AMT provides a substantially higher exemption level but does not recognize certain deductions available through the regular tax code such as state and real estate taxes. Depreciation and medical expenses are calculated differently under AMT along with a host of more obscure deductions and income offsets. The actual tax rate is almost flat at between 26% and 28%. Taxpayers pay the higher of the tax computed under the normal tax regulations or the tax computed under the AMT. If the AMT is higher, the difference is added to the regular tax liability. The AMT is shown as an additional line item as if it is a separate tax on income.

The Rise of AMT

For the first 25 years of its existence, the AMT was the tax equivalent to Bigfoot or the Loch Ness Monster. It was written about, feared, and occasionally sighted, but few had actual experience with the creature. Beginning in the late 1990’s, AMT became a more regular occurrence. Taxpayers with large capital gains, stock option transactions, or large itemized deductions began to encounter the hidden tax with more frequency and more frustration. By 2009, around 4 Million taxpayers were subject to this “new” tax. The tax was no longer just an enemy of the ultra-wealthy. It could strike almost anybody in a given year depending on their circumstances.

Good Intentions – Unforeseen Consequences

The original AMT was targeted at a group of 155 taxpayers that made an astounding sum of over $200,000 per year in 1969. The framers of the act failed to include any inflation adjustments in the calculations so as time went by the taxpayers included in this formerly select club rose substantially. Finally in 2013, Congress corrected this oversight by indexing the AMT threshold for inflation. While the move curbed the flight to the unwanted flat tax, it is still a very real consideration for taxpayers.

Consider this rather sobering table:

You could owe AMT for tax year 2015 if your taxable income is more than:
$83,400 for a married couple filing a joint return and surviving spouses.
$53,600 for singles and heads of household.
$41,700 for a married person filing separately.

Know the Warning Signs

Unsuspecting AMT recipients may very well significantly underpay their tax liability, waste deductions that could otherwise be taken in a non-AMT year, or pay higher taxes on capital gains and qualified income. The first step to dealing with AMT is knowing when you need to be wary of it.

If you have significant capital gains, qualified dividends, Incentive Stock Option (ISO) exercises, or tax exempt interest on bonds used to finance private activities, you’ll want to make yourself or your CPA aware of the potential danger. You may be able to structure these transactions in a way that limits your exposure to AMT, so consult an expert in advance of any action.

If you have significant itemized deductions relating to deductible taxes, miscellaneous itemized deductions, or certain tax preference items such as intangible drilling cost or depletion, the AMT may be a frequent challenge. Also, if you have a change in filing status, particularly (married filing separately) make sure you understand where you stand with regard to the AMT provisions.

Sweet Revenge – Good AMT vs Bad AMT

If you have already been bitten by the AMT bug, all hope is not lost. All AMT is NOT created equal. Good AMT is eligible to be recovered in later years through the use of the AMT credit. Bad AMT needs no further explanation. In general, AMT generated by deferral options (exercise of ISO’s) is potentially recoverable, while AMT due to exclusions items (deductions) is most likely not.

We may never see a truly flat tax in our lifetimes and we may never be able to rid the tax code of its more sinister cousin, the AMT. As we carry on trying to be good citizens and model taxpayers, we can continue to hope for the former, but we must be prepared to deal with the latter.

SHARE THIS!Share on LinkedInTweet about this on TwitterShare on FacebookGoogle+
Read More »

Steve Forbes ran for the Republican nomination for President in 1996. While not a true single issue candidate, Forbes platform was concentrated on the central issue of scrapping the existing internal revenue code and replacing it with a flat tax of 17%. Forbes was unable to garner significant support in either of his runs for…

Read More »

Previous post:

Next post: