Posted on: Sunday, March 21, 2004

Tax cuts backfire for millions of households

By Jonathan Weisman
Washington Post

I reported on every jot and tittle of last year's $350 billion tax cut, so it was with some relish that my wife loaded our tax software last month to learn just how generous President Bush would be with our tax rebate.

Our answer: What George W. Bush had bequeathed, the alternative minimum tax (AMT) had rescinded, to the tune of $2,143.

The parallel income tax system, enacted more than 30 years ago to ensure the rich paid their fair share, had bitten us hard.

When the AMT and its precursors were enacted, Congress neglected to allow its thresholds to rise with inflation, as ordinary tax brackets do. So more and more taxpayers were ensnared.

An estimated 2.5 million households will be socked this spring by the AMT, up 400,000 from tax year 2002. That figure will rise quickly — to 3.2 million in 2004, 12.1 million in 2005 and 14.9 million in 2006, according to the IRS' taxpayer advocate's office.

By 2010, the AMT will hit about 30 million taxpayers, most with incomes under $100,000. At that point, the AMT will be the de facto tax system for any household with income between $100,000 and $500,000, the taxpayer advocate said. At decade's end, 97 percent of married taxpayers with two or more children and income of $75,000 to $100,000 will be affected by the AMT.

Much of this exponential rise is, ironically, due to Bush's tax cut. As effective ordinary tax rates fall, more taxpayers will dip below the AMT's 26 percent and 28 percent tax rates. That will ensure that tens of millions of households will not see the full fruit of Congress' largess.

"The bad news before was that you had to pay higher regular taxes, so when they lowered regular taxes, you thought that was good," said Chris Sintetos, an accountant at Argy, Wiltse & Robinson in Tysons Corner, Va. "But when the taxes came down, they dropped us below the AMT threshold."

"A lot of people are giving away what they thought they were getting," he added, "as much as 35 percent (of their tax cut)."

IRS officials say they have yet to hear the outrage en masse. Congress did increase the AMT exemptions for individuals and couples in the 2001 tax cut, and widened them again in the 2003 tax cut. But those AMT "patches" expire at the end of this year, and they only went so far anyway.

Accountants point to high taxes and escalating real estate values for the rising number facing an AMT hit. Taxpayers are allowed to deduct taxes paid to state and local governments from ordinary income taxes, but not from alternative minimum taxes. So two-income homeowners with high local taxes are now AMT bait.

You don't even have to be rich. The IRS taxpayer advocate recently noted that the number of taxpayers with taxable income of less than $50,000 with an AMT bill in 2001 was virtually identical to the number with taxable income between $475,000 and $500,000.

Both the Republican and Democratic tax writers know the situation cannot last. The AMT cliff in 2005 — when the number affected quadruples — may be the end of the road for this tax system.

Fixing the problem will be expensive. Assuming Bush's tax cuts are not allowed to expire, continuing the AMT "patch" would cost $658 billion over 10 years, according to the Congressional Budget Office. Full AMT repeal would exceed $1 trillion, the Tax Policy Center says.

That may not be affordable unless repeal comes with tax increases or dramatic spending cuts. That's why the smart money says that sometime in the coming few years, lawmakers will have to sit down and rewrite the entire tax code and federal budget.