The New Tax Trap

By Daniel Kadlec

Tax reform is on the national agenda again. Yet no one is doing anything about the most dreaded levy of them all: the alternative minimum tax. You have probably heard about the AMT and may have to pay it soon enough if you aren't already doing so. Join the club. Here's a primer on the most reviled tax since the Boston Tea Party.

*WHAT IS THE AMT?

It is a parallel tax code, launched more than four decades ago. Outraged that 155 wealthy families had used loopholes to avoid paying any federal income tax in 1967, Congress in 1969 enacted the first of a string of laws that led to the AMT and were designed to strip away deductions that enabled the rich to avoid taxes. Today, millions of people must calculate their taxes twice--once the traditional way and once the AMT way--and owe whichever calculation is higher. Among other things, the AMT effectively disallows the standard deduction and child deductions as well as deductions of state and local income taxes, certain legal fees and medical expenses and the interest on home-equity debt not used to improve your property or build a second home.

*ISN'T THIS A PROBLEM ONLY FOR THE RICH?

No. In fact, most of the rich don't pay it. You can be liable for the AMT's extra bite with a household income as low as $75,000, and you are more vulnerable the more kids you have. Hardest hit are the upper middle class: households earning $200,000 to $500,000 a year. More than half in this range pay the AMT, while only one-quarter of households earning over $1 million each year pay it.

*WHY IS THE AMT SO HATED?

Critics argue that the AMT is hitting the wrong people, ensnaring more and more middle-class families. Although just 2% of families with two or more children and household earnings of $75,000 to $100,000 a year pay the higher tax today, within five years virtually all such families will pay it--and the AMT will have moved further down the income bracket to some earning as little as $50,000 a year, projects the Tax Policy Center, a nonpartisan research group whose estimates are widely accepted. Put another way: 3 million taxpayers will fall victim to the AMT this year; that number is scheduled to climb to 19 million as soon as next year and to 30 million--one-third of all taxpayers--by 2010.

*WHY IS THE AMT INCREASINGLY REACHING INTO MIDDLE-CLASS POCKETS?

The regular tax code automatically lifts tax brackets and increases deductions and exemptions each year to reflect the higher cost of living and rising wages over time. Not the AMT. There have been patchwork fixes, but without an inflation adjustment, more middle-class families fall prey each year as their income simply keeps pace with costs.

*HOW MUCH MIGHT THE AMT COST ME?

That depends on many variables including your income and deductions. But a couple earning $75,000 to $100,000 a year and has two or more kids pays, on average, $2,400 a year of additional tax when they fall into the AMT zone.

*CAN'T THIS BE FIXED?

Only at a huge cost. To the federal government, the AMT has become a cash cow, projected to generate $660 billion of tax revenue over the next 10 years. In 2010 alone, the AMT will bring in $105 billion of additional tax revenue, or 9% of all federal income tax. Plagued by deficits, Congress is loath to turn its back on this bonanza--especially since it hits a relatively small political constituency.

*SO IS THE AMT POLITICALLY MOTIVATED?

Some charge that Republicans have been slow to act on the AMT because it strikes traditionally Democratic states hardest. There is no denying that Democratic strongholds New York, New Jersey, Massachusetts and California are top AMT payers, mainly because of their above-average incomes and state and local tax burdens--two key AMT triggers. "There are some conservatives who look at that with a certain glee," notes Len Burman, a co-director at the Tax Policy Center in Washington. But with the AMT about to swamp the middle class in all states, both sides of the aisle have plenty to lose as taxpayer frustration builds.