"Mandatory Maximum Tax" amounts to double taxation

by Tom Arneberg, Community Columnist

Well, we are done with another tax season. (I'm glad I finished filing my tax returns early this year -- I'd hate to be scrambling to finish when the temperatures finally hit the 70s in mid-April!)

I was at a financial planning seminar a few weeks ago when the speaker turned his focus to a formerly obscure piece of the U.S. tax code that is getting more attention lately: the Alternative Minimum Tax, or AMT.

This guy said it was misnamed. He said it really should be MMT: "Mandatory Maximum Tax." First, it's not an alternative in the normal sense of the word -- if you "qualify," you HAVE to compute your taxes that way. Second, it's not the minimum of the two calculations, it's the MAXIMUM of the two. Calling it "MMT" makes sense to me, but it doesn't help me appreciate it any more.

What is AMT, and why do we need it? As with most laws, there was a valid reason for this one when it was originally written. Back in the 1960s, when marginal tax rates were through the roof for upper-income earners, tax shelters abounded to take advantage of loopholes in the tax code.

There was a small number of fat cats -- 155 of them, to be exact -- who managed to avoid paying ANY income tax, despite being ultra-rich. To remedy this, Congress in 1969 enacted the AMT to make those people pay at least SOME income tax.

Unfortunately, the AMT was never indexed to inflation the way other brackets have been for the past two decades.

You can guess what is happening, as incomes rise with inflation. A tax law written for 155 people -- literally one person in a million -- now affects over THREE MILLION of us, and is projected to affect more than 30 million taxpayers by 2010, unless something is done to address it.

Some complain about the extra time needed to fill out the AMT forms -- 12 hours, according to the government's own estimates. But frankly, I think anyone who fills out the 1040 manually is nuts, when you can go down to Best Buy and plunk down $20 for Turbo Tax and have it do all the grunt work for you. No, what I really hate about AMT is simply having to pay more money in taxes!

Who does it affect? For starters, I can tell you from personal experience that it is no longer limited to "the rich." Rather, it hits people who have high tax deductions. If you have a lot of kids, or a big property tax bill, or high state taxes, you are in danger of the AMT. If you fit ALL those categories, watch out!

The net effect of the AMT is to disallow deductions. When computing AMT, you throw away deductions for your dependents. Likewise, state taxes and property tax payments are not deductible under the AMT calculations.

This amounts to double-taxation -- with deductions tossed out, the same money I earn and pay to the state of Wisconsin and to our school district is taxed AGAIN by the feds. The reason for allowing taxpayers to deduct state and local taxes is to prevent paying taxes twice on the same income, but the AMT destroys this reasonable goal.

The property tax hurts the worst. It's bad enough to have to pay double taxes since the deduction is not allowed under the AMT, but property taxes in general amount to a tax on savings, not earnings. Why should people be penalized based on how they choose to save and spend their money?

Suppose a family lives significantly below their means for 15 years, and continues to drive old cars and live frugally. But because they channeled their savings into a house, they get the "privilege" of paying a hefty tax on their real estate investment year in and year out. This truly is the tax that keeps on taking. And to get taxed AGAIN on that tax adds insult to injury. But I digress.

In her annual report to Congress, Nina Olson, the IRS's National Taxpayer Advocate, called the Alternative Minimum Tax "horrible," and said it's the biggest problem taxpayers face today. "It's a time bomb on a short fuse," she warns.

Getting back to the financial planning seminar I attended -- the teacher said that students could talk to him after the class if they wanted advice on how to minimize their chances of getting hit by the Mandatory Maximum Tax. When everyone else had left the room, he listened to my situation, and basically said, "Sorry, buddy, you're out of luck." No amount of planning can sidestep this pernicious tax bite.

Mark my words, you will be hearing more about AMT. As it continues to hit more and more average taxpayers, there will be increasing pressure on Congress to address it. Let's hope they have the courage to fix this mistake.

I hope I haven't discouraged you with my ranting about the U.S. tax code. I think it's time to go outside and enjoy some spring sunshine -- at least that's still free.

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You can reach Tom at toma@arneberg.com.