State-Local Deduction is Key to the AMT

May 21, 2007

In a new report, the Tax Foundation has shown that the tax code has worse problems in its regular income tax than in its alternative minimum tax (AMT). Luckily, if we fix those problems in the regular income tax, we’ll solve the annoying AMT at the same time.

People on the left and right try to portray the AMT as the bane of the middle class. In fact, people in the middle 20% of American earners ($42K – $64K in 2004) are almost never “in AMT.” In 2004, less than one of every 1,000 tax returns paid the AMT in this income range.

What if we expand the definition of “middle-income” to the one given by Senator Baucus in recent hearings — the middle 60% of earners ($23K – $99K)? Even in this larger group containing more dual-income couples, less than 1% of the tax returns have to bother with the AMT.

The biggest cause for AMT filings is the deduction taken by high-income people for their state-local property and income tax payments. The regular tax code allows the deduction, but the AMT takes it away. Which is right?

People who live in big, valuable homes pay a lot of property taxes, especially since the run-up in real estate values from 2000 to 2005, and they want those high payments deducted on their federal tax returns. But is there really a good reason for the nation’s renters and owners of cheap property to subsidize the owners of valuable property through the tax code?

Similarly, the residents of states with high income taxes get big deductions on their federal tax returns, but if the AMT kicks in, they lose those deductions. Irritating yes, but why should the residents of low-tax states pay more to the federal government so that people in high-tax states can enjoy the benefits of high state spending?

In sum, no matter how annoying the AMT is, its denial of the deduction for state-local taxes is correct. If Congress would eliminate that deduction in the regular tax code, almost no one would be kicked into AMT, and the tax code would be a more fair and efficient tool for the nation.

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