The Individual Alternative Minimum Tax: Historical Data and Projections: Updated June 2008

www.taxpolicycenter.org The Individual Alternative Minimum Tax: Historical Data and Projections, Updated June 2008 Greg Leiserson and Jeffrey Rohaly Congress originally enacted a minimum tax in 1969 to guarantee that high-income individuals paid at least a minimal amount of tax each year.1 Due to design flaws, however, the current alternative minimum tax (AMT) threatens to grow from a footnote in the tax code to a major component affecting tens of millions of taxpayers every year. One reason for the projected expansion of the AMT is that – unlike the regular income tax system – the AMT brackets and exemption are not indexed for inflation. In addition, since they reduce regular income taxes without a corresponding permanent fix to the AMT, the 2001-06 tax cuts exacerbate the AMT problem. Absent a change in law, more than 33 million taxpayers will be subject to the AMT by 2010. If Congress allows the tax cuts to expire at the end of 2010, the number of AMT taxpayers will fall dramatically in 2011, but will then trend back upward over time. By 2018, about 43 million taxpayers will be subject to the AMT under current law; that number will swell to almost 57 million if the tax cuts are extended. Although most lower- and middle-income taxpayers will remain unaffected by the tax, policymakers will need to deal with the explosive growth of the AMT from an obscure tax affecting only 20,000 filers in 1970 to one affecting more than a third of all taxpayers by 2010. The Tax Policy Center (TPC) has written extensively about the AMT.2 This paper updates Rohaly and Leiserson (2006) with the TPC’s latest estimates of AMT participation, revenue, and the distribution of AMT liability.3 It starts with a brief overview of how the AMT works. Leiserson is a research associate at the Urban Institute and the Urban-Brookings Tax Policy Center (TPC). Rohaly is a senior research methodologist at the Urban Institute and the director of tax modeling for the TPC. Views expressed are those of the authors alone and do not necessarily reflect the views of The Urban Institute, its Board or its funders. We thank Bob Williams for helpful comments and suggestions. 1 The original minimum tax was an addition to regular income tax. The current AMT is a floor on total tax liability. For details see Burman, et al. (2002). 2 See, for example Burman, Gale, and Rohaly (2005), Burman and Leiserson (2007), Burman and Weiner (2005), and Burman et al (2007). 3 The source for our estimates is the Urban-Brookings Tax Policy Center Microsimulation Model (version 0308-5). Estimates presented in this paper differ slightly from earlier projections because of an update in our underlying database and changes in the economic forecast included in the newest version of our tax model. For a brief description of the tax model, see http://www.taxpolicycenter.org/numbers/related.cfm. 2 How the AMT Works4 The individual AMT operates parallel to the regular income tax, with a different income definition, rate structure, and allowable deductions, exemptions, and credits. After calculating regular tax liability, taxpayers must calculate their “tentative AMT” under the alternative rules and rates and pay whichever amount is larger. To calculate tentative AMT, taxpayers determine the AMT tax base, apply the AMT tax rate and exemption phaseout schedules, and then subtract applicable credits. Technically, AMT liability is the excess, if any, of tentative AMT above the amount of taxes due under the regular income tax; you pay your regular tax and then tack on your AMT liability. Alternative minimum taxable income (AMTI) is the sum of three components: regular taxable income for AMT purposes, AMT preferences, and AMT adjustments. Regular taxable income for AMT purposes is basically the same as taxable income for regular tax purposes except it may be negative if deductions exceed gross income. An AMT preference is an item identified as a potential tax saving in the regular income tax that is not permitted in the AMT. An AMT adjustment is simply any exclusion, exemption, deduction, credit, or other treatment (such as a method for computing depreciation) in the regular income tax that is either restricted or disallowed in the AMT. There is no interesting economic distinction between preferences and adjustments; we will generally refer to both as preferences. Interesting distinctions do emerge among the various preferences themselves, however. Preferences are of two types: exemptions or deferrals. Exemption preferences broaden the AMT tax base, and include the disallowance of personal exemptions, the standard deduction, and itemized deductions for miscellaneous expenses and state and local taxes. Deferral provisions change the timing of the recognition of income and deductions, typically to accelerate income and postpone deductions. Thus, they tend to raise the current-year tax base, but only at the expense of future