1986 Simplification Gives Birth To The Monster AMT We Have Today

The quest for simplification, lower rates and fairness in 1986 was a worthy undertaking, even if short lived. Included as a mechanism to achieve those lower rates was a reformulation of the minimum tax scheme in effect at that time in an effort to “broaden the base” of those subject to the tax. The tax rate increased from 20% to 21%, the basic exemption amount was changed and a revamped alternative minimum tax credit was introduced. It also brought a phase-out of the AMT amount for taxpayers whose alternative minimum taxable income (AMTI) exceeded certain limits.

Some would suggest the most significant change affecting the AMT at that time was modifications in the tax treatment of capital gains income under the regular income tax. The 1986 Act repealed the exclusion for long-term capital gains income and capital gains income was taxed in full under the regular income tax; it was no longer taxed as a tax preference item under the AMT. This change substantially reduced the number of taxpayers subject to the AMT initially. However, I believe the most significant change was the inclusion of family-related adjustments in the base of computing income subject to alternative minimum tax.

The mechanism to accomplish this treatment was to begin the calculation of AMTI after itemized deductions, but before personal exemptions. Schedule A itemized deductions for state and local taxes, miscellaneous deductions such as employee business expenses, a portion of deductible medical expenses and some residence interest deductions were added back to the AMT taxable base. Personal exemptions were eliminated, and in their place was an AMT exemption amount based on filing status, but subject to a high-income phase out.

Special Report: 25 Years After Tax Reform, What Comes Next?

AMT did not create a significant source of added revenue in the early years because the exemption amount was adequate to keep most middle-income taxpayers out of the system. Unfortunately that exemption amount was not indexed for inflation, and has only been increased permanently one time in the last 25 years, with the Revenue Reconciliation Act of 1990.

As the years passed and inflation-induced increases to taxpayer incomes occurred, more lower and middle income taxpayers became subject to the snare, even to the extent that Congress passed a permanent provision that allows Earned Income Credits to be applied to one’s AMT!

Alternative Minimum Tax became a Mandatory Maximum Tax.

Our Congress deems making a permanent change to the exemption amount “too costly,” so for the last decade temporary fixes have been made to increase the exemption amount a few years at a time. The current fix is set to expire at the end of 2011. Unless Congress acts again to place a band aid on the fistula, 34 million taxpayers will incur this tax in 2012.

Taxpayers are frustrated by now-you-see-them, now-you-don’t approaches to remedying the problems our tax system faces. They are tired of the uncertainty presented each time a short-term solution is placed to resolve a long-term problem. They are frustrated by a system that inappropriately targets young families struggling to buy their first home and care for their children.

Is there a lesson in this? Constant tinkering with one aspect of our tax system without a thorough analysis of overall interactions generates unexpected and unintended consequences. Simplification is complex.

Special Report: 25 Years After Tax Reform, What Comes Next?