The Alternative Minimum Tax (AMT) is a parallel tax system that is ensnaring more and more US taxpayers each year due to the fact that its brackets are not indexed for inflation and many popular deductions (such as state and local taxes) do not apply. Check the sidebar under “Taxes” for articles on this and related topics.
On April 18 the Wall Street Journal wrote an article titled “The ABC’s of Dealing with the AMT”. While I am a big fan of the WSJ in general this article fell far below their typical standards and literally had me laughing out loud a couple of times.
First of all, the article had nothing to do with the topic of their title. There really isn’t anything substantial that you can do to avoid the AMT unless you want to engage in serious tax avoidance with actual economic consequences, such as actually earning less money. This should be the topic sentence – once you are in the AMT range, you are essentially trapped there forever, unless you suffer from economic misfortune. Thus their “dealing with it” answer should be to prepare to set aside more money for taxes and to curb consumption elsewhere, because it is unavoidable.
Here’s the first howler in the article:
"I believe I make a good living, but I thought this was something that only affected the higher-higher income people," says Stephen Payne, a certified public accountant who lives in Longmeadow, Mass., and says his family's adjusted gross income last year was about $106,000. "It seems unfair." Mr. Payne says he paid about $500 in additional tax for 2006 thanks to the AMT.
Let’s examine this sentence a bit (which is more than the journalist who wrote this article did) – a CERTIFIED PUBLIC ACCOUNTANT was surprised that he was in the AMT. This guy ought to have his CPA certification taken away if he was surprised by a key set of the tax code that has been around for decades. I could see how he’d be upset by being ensnared by the AMT, but being surprised is ridiculous. In addition, anyone who is a CPA should realized that “fairness” isn’t even in the top 100,000 concerns of the IRS and the US tax code; it is a mess of conflicting deductions and principles that rub each other raw and don’t agree fundamentally if their task is 1) raising revenue for the government or 2) “rewarding” behavior favored by our legislature who sponsor the amendments.
Here is the second completely incorrect passage:
Among those most likely to be affected by the AMT this tax season were people with income between $200,000 and $500,000 and who live in high-tax areas, such as New York City; Washington, D.C.; California; Connecticut; and New Jersey, says Mr. Burman of the Tax Policy Center. Mr. Hopwood, the American Express executive who works in Manhattan but lives in Fair Lawn, N.J., took a big hit when he realized he could no longer deduct his state and local taxes. "I'm kind of being punished for working in a high-tax state," he says.
It is a true statement that the most likely people to be impacted by the AMT are those individuals that live in a high tax state. However, the element that is COMPLETELY INCORRECT is the executive’s statement that he is being punished for working in a high-tax state. No – what is occurring is that the tax code is no longer SUBSIDIZING him for working in a high-tax state. The tax benefit of being able to deduct state and local taxes (under the "base" tax code, not the AMT) was written into the code SPECIFICALLY to benefit taxpayers in states like New York and California – there is no benefit to someone who lives in a (typically high growth) state like Texas, Florida or Nevada from this provision in the tax code, because they don't pay high state taxes. This benefit goes to the richest people in the richest states, and is not “fair” to quote from the first howler the surprised CPA, above.
On a related note I overheard someone saying that they were going to pay off their mortgage because their accountant explained to them how the AMT was working and that they no longer were able to deduct their property taxes so net, their mortgage wasn’t financially advantageous. This is a true statement and one that likely will begin to weigh on the real estate market – if you are buying an expensive house with a big mortgage in a state like New York or California with high state taxes, you won’t be able to deduct either your state taxes or your high property taxes since you likely will be pushed into the AMT. Over the long haul, as common “folk wisdom” about the advisability of real estate as an investment (it is land, not the building) is replaced by an objective reappraisal of its value as an investment, this will be a double hit against these high tax states.