Thursday, November 29, 2007

Alternative Minimum Tax Mess Delays IRS Refunds

You can expect your income tax refund next year to be delayed. Despite fervent promises, Congress didn’t deal with the alternative minimum tax before Thanksgiving. Although Congress can be expected to fix the AMT (at least for this year) after it gets back from the Thanksgiving break, the IRS will need about ten weeks to program its computers to incorporate the fix. Consequently, refunds will be delayed.

The alternative minimum tax is the shadow tax system that affects more and more people. It was originally enacted in 1969 because of outcries over a few wealthy persons who paid little or no any income tax under the regular tax code. The AMT was meant to prevent the wealthy from using a variety of deductions and other provisions to avoid paying taxes.

However, the AMT is seriously flawed. It does not adjust for inflation. Thus, it reaches farther down the economic ladder as nominal incomes rise with inflation. The regular income tax brackets are raised to account for inflation, so the federal government doesn’t get an automatic revenue boost simply from the cheapening of the currency. But the AMT is the ace up the government’s sleeve. Depending on how much additional income it wants each year, the government enacts the “patch” on the AMT annually to bring in extra revenues the regular tax code wouldn’t have provided. It's true that the patch prevents full application of the AMT (which would reach into the middle middle class), but the patch nevertheless results in taxation of a lot of people who will never own a yacht.

The lurking presence of the AMT means that taxpayers have to do two calculations of their tax liability each year: once for the regular tax code and a second time for the AMT. Both calculations are required even if you don’t owe any AMT, because you can’t determine that you owe no AMT until you do both calculations. Thus, the AMT means more work for you at tax time even if you don’t owe more tax.

The AMT is schizophrenic, as taxes go. Some of the benefits it penalizes are long term capital gains, accelerated depreciation, percentage depletion allowances, and income from specified private activity municipal bonds (i.e., revenue bonds). This sounds like the AMT as it was originally intended. Most people who work in cubicles and drive Dodge Neons or Honda Civics don’t report many of these items on their tax returns.

But other deductions that are penalized by the AMT include state and local taxes, and personal exemptions (read, exemptions for dependent children). What are they smoking on Capitol Hill? Do people sneak around and pay state and local taxes with sly smiles in order to slip one by the IRS? Do people have children in order to flip off the tax man? Given America’s demographic problems, with increasing numbers of older people expecting smaller numbers of younger people to cover their Social Security payments, why does it make sense to tax parents more for having children?

The flaws of the AMT notwithstanding, there is little hope for serious change. The AMT provides tens of billions of dollars of extra tax revenues each year. It reaches into the upper middle class and extracts extra payments from millions of people who are not tax-dodging filthy rich, but rather those with large families who live in states with high state income taxes. The federal government is now mainlining revenues from the AMT and, with the mammoth budget deficits it runs, it won’t kick the AMT habit any time soon.

So the most you can expect is another ad hoc patch in the next few weeks, whose tardiness will delay your refund. Hopefully, Congress and the IRS will also give us extra time to get our tax returns filed, since we probably won’t be able to get instructions and forms on how to comply with the “patched” AMT at the crack of dawn on Jan. 2, 2008. But heaven forbid that we should hope for dispensation from the tax system.

Legal News: the judge that didn't like cell phones.

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