The Sneaky Way Tax Reform (Almost) Killed the AMT
Tax time is just around the corner, and this tax season will mark the last time you have to file your taxes using old tax rules. For 2018, the newly passed tax reform law will take effect, and many changes will apply to the 2018 returns you file in early 2019. Headlines have already trumpeted the lower tax brackets, higher standard deductions, and larger child tax credits that tens of millions of taxpayers will see come next year.
Yet one provision in tax reform will largely affect upper-middle class and high-income taxpayers. Changes to the alternative minimum tax provisions will eliminate the additional tax for corporate taxpayers, and although the AMT stays on the books on the individual side, the somewhat sneaky way in which lawmakers changed key provisions of the alternative minimum tax has largely taken away the negative impact of its continued existence. Let's look more closely at the AMT and how Congress just almost got rid of it.
A generation of AMT
Taxpayers have had to deal with the alternative minimum tax in its most recent form since the early 1980s. The general idea back then was that with so many deductions available, lawmakers wanted to ensure that everyone paid at least some base minimum of tax regardless of how many tax breaks they could use to their advantage.
Over time, because the AMT's exemption amounts initially weren't indexed to inflation , the tax snared an increasing number of taxpayers. Although the tax was originally set high enough to capture only high-income households, rising wages and incomes threatened to make millions more taxpayers subject to the AMT. Some stopgap measures provided relief from the tax for years, and the tax changes five years ago related to the fiscal cliff made those measures permanent. Yet even with inflation indexing, the AMT still affected a much broader set of people than originally intended.
How lawmakers defanged the AMT
Congress could simply have eliminated the individual AMT , as they did for the corporate version of the tax. Yet they chose a more subtle approach that will have the same net effect for most taxpayers without officially taking the AMT off the books.
Specifically, what Republicans did was to propose an increase in the exemptions that apply to the AMT. By raising the exemption amounts, lawmakers effectively widened the 0% rate under the AMT, making it that much harder for the alternative minimum tax to exceed the ordinary income tax liability for given taxpayers.
Old AMT Exemption
New AMT Exemption
Data source: IRS.
With the AMT starting at a rate of 26%, the increases reduce potential AMT liability by more than $4,400 for singles and almost $6,500 for joint filers.
Yet the bigger change came in the way that lawmakers changed how the exemption amount phases out. Under old law, you started losing $1 of your AMT exemption for every $4 in extra income above a certain phase-out amount. Those phase-outs used to occur at $120,700 for single filers and $160,900 for couples. That phase-out effectively increased the 26% and 28% tax rates under the AMT to a marginal rate of 32.5% and 35% for those in income levels that reflected the phase-out. With ordinary tax rates of 25% and 28% applying to much of that income for regular tax purposes, the difference of roughly seven percentage points caused AMT to add up dramatically.
Now, the phase-outs will start at $500,000 for singles and $1 million for joint filers. By that point, tax rates of 35% and 37% are already in effect, so even effective AMT rates of 32.5% and 35% won't actually result in any additional tax.
Not dead yet
There are some situations in which AMT will still play a role. For those who have huge amounts of income that are taxed under the AMT but not taxed under the regular tax system, AMT could still have an impact. Yet even there, other elements of tax reform will lessen the chances of the alternative minimum tax coming in. The biggest example is state and local taxes, which were never deductible under AMT and are now only deductible up to $10,000 under the new regular tax provisions.
For most of the relatively few taxpayers who had to deal with this provision, the tax reform law has done a good job of eliminating the net impact of the AMT. Only in extreme cases will the alternative minimum tax remain relevant at tax time this time next year.
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