Alternative Minimum Tax Increase Looming Over Fiscal Cliff Negotiations
December 14, 2012
It's looking increasingly likely that Congress won't come to a deal on the Fiscal Cliff by the end of the year. If that happens, taxpayers will feel the effects immediately – paychecks will be noticeably smaller, due to both increased income tax withholding and an increase in payroll taxes. However, Congress can and often does change tax laws retroactively – this is because you don't file your tax return until the April after the tax year for which it applies. It's quite possible for Congress to go "over the cliff" and then re-enact most or all of the Bush-era tax cuts later on during the year – taxpayers can reclaim their overpayments when they file their 2013 tax return in April 2014. However, there is one major provision where this doesn't apply – the Alternative Minimum Tax (AMT). The key changes have already happened, and a very substantial tax increase will affect millions of 2012 tax returns to be filed only months from now unless Congress does something about it in the next sixteen days.
The AMT is comparable to a parallel universe – it's a completely separate income tax system, with its own definitions of taxable income, tax rates, tax brackets, deductions, and exemptions. When taxpayers file a return, they calculate their liability under both the regular tax and the AMT, and they owe whichever is higher. For the vast majority of taxpayers, the regular tax is higher than the AMT, and it's not something they need to worry about. However, for certain taxpayers (generally upper-middle class families with children) tax liability under the AMT can be significantly higher than the regular tax.
The regular tax code is indexed for inflation; tax brackets rise every year so that higher tax rates that were originally intended to apply only to very wealthy taxpayers don't creep downward to affect lower incomes. This happens automatically, without the need for Congress to act. Not so for the AMT – all of its parameters are permanent. Congress's solution to this easily fixable problem has been to pass temporary "patches" raising the base AMT exemption amount for one or two years. It's important to emphasize that these patches are temporary – if the current one is allowed to expire, the AMT exemption amount will return to what it was in 1993, which was the last time Congress made a permanent, rather than temporary, change to the AMT. (Politicians are generally unwilling to pass a permanent fix because the CBO would score it as large deficit increase.)
Why can't Congress address this next year, like the rest of the fiscal cliff? Because the most recent AMT patch already expired at the beginning of this year. Right now, there is no AMT patch in place for 2012. The IRS is currently putting together the tax forms you'll use next year to file your 2012 taxes, and as far as it's concerned, this year's AMT parameters are what they were twenty years ago, despite 60% inflation since then. Once January 1st comes, the clock runs out – the year's over and the IRS needs to release the forms so that people can file their returns. Again, this is in contrast to the rest of the Fiscal Cliff tax provisions, which expire a year later and will affect the 2013 tax return that you file in 2014, not the one you file next year.
This would be a substantial tax increase that would affect many taxpayers. According to calculations by the Tax Policy Center, the number of taxpayers owing AMT would rise 600% – from 4.3 million last year to 31.2 million this year. For many families, the increase would be even larger than from the Bush tax cuts. Let's look at an example family of four – each parent earns $60,000 in wages, and they deduct $7,000 in state/local income taxes, $3,000 in property taxes, and $10,000 in mortgage interest. Our calculations suggest that they would see a tax increase of $4,850 over last year – a 40% income tax increase. Contrast this with the Bush tax cuts – while this is obviously a bit of a contrived scenario, if you compare 2013 with no Bush tax cuts (but with an AMT patch) to 2011, you get an income tax increase of $3,211, or 27%. Still substantial, but not as much as the AMT increase.
It's not clear that negotiators understand the urgency of this problem. This year's tax code ought to be fixed before we worry about next year's.