On lawmakers' minds: Paying for AMT reform

NEW YORK (CNNMoney.com) -- When it comes to the Alternative Minimum Tax (AMT), the question on lawmakers' minds these days isn't "Should it change?" but "How should it change?" ... and, not insignificantly: "How should we pay for it?"

The estimated cost of changing the AMT ranges from $50 billion for one year of relief to more than a trillion dollars for long-term reform or repeal.

More than 23 million taxpayers in tax year 2007 will be hit with the stealth wealth tax if nothing is done to shield middle- and upper-middle-income taxpayers. And after that, the picture just gets uglier.

Indeed, those hardest hit would be married couples with kids who take a lot of the deductions and credits disallowed under AMT. The Tax Policy Center estimates that by 2010 nearly 90 percent of married couples with two or more children and an adjusted gross income between $75,000 and $100,000 will be subject to AMT, which carries a higher tax bill than what you would pay under the regular tax code.

But realistically, there is very little chance that lawmakers will allow that to happen. If AMT relief, which expired at the end of tax year 2006, is extended, instead of 23.4 million taxpayers being hit in 2007, only 3.8 million will have to pay AMT and the majority of those taxpayers will have incomes over $200,000, according to the Tax Policy Center.

First imposed in 1969, the AMT was originally intended to insure the wealthy paid their fair share of tax and didn't abuse the tax breaks allowed under the regular code. But because its income parameters were never adjusted for inflation over the past 37 years, it threatens to catch tens of millions of non-wealthy taxpayers in the years ahead.

For the past six years, lawmakers have put in temporary "patches" to stem the potential flood of middle- and upper middle income taxpayers from having to pay the AMT. They did so by increasing AMT income exemption levels and allowing certain credits to be taken that otherwise would have been disallowed.

This week Sen. Charles Schumer (D-NY) along with several freshman Democratic senators, proposed legislation that would, among other things, provide AMT relief for middle-class families through 2008, according to Congress Daily.

In early January, Senate Finance Committee Chairman Max Baucus (D-Montana) and Ranking Member Charles Grassley (R-Iowa) introduced a bill to fully repeal the AMT.

And on Friday, The Wall Street Journal reported that administration officials have "quietly" suggested that President Bush might not object to raising taxes on upper-income taxpayers to pay for AMT relief for everyone else.

The paper also noted that one option being considered by Democrats would permanently exempt taxpayers with incomes up to $250,000 from the AMT, provide graduated AMT relief for those making between $250,000 and $500,000 and then impose either a higher AMT tax rate or higher regular income tax rate on those making $500,000 or more.

In a press briefing on Friday afternoon, White House Press Secretary Tony Snow said the administration is talking with Democrats and Republicans about ways to change the AMT, and indicated that the White House isn't imposing any preconditions on a fix. "We don't think it needs to involve tax increases, but we're certainly open to hearing what other people have to say," Snow said.

Under Congress' new "paygo" rules any revenue losses must be offset by revenue increases in other areas. And House Speaker Nancy Pelosi (D-Calif.) said at the start of Democrats' tenure as the majority party that she wouldn't rule out rolling back some of President Bush's tax cuts on those making $500,000 or more.

Those tax cuts - including a lower capital gains rate and lower income tax rates - expire at the end of 2010, unless lawmakers choose to extend them.

Beneath general agreement that change is needed on the AMT lie a lot of disagreements.

Grassley, for instance, is among those who don't believe money needs to be raised to make up for the loss of the AMT since much of the revenue would be raised unfairly. "It is simply unfair to expect taxpayers to pay a tax they were never intended to pay, and it is even more unfair to expect them to continue paying for that tax once we get rid of it," he said in a statement this week.

Others disagree, asserting that because federal budget projections assume the AMT in its original form stays on the books, that made the long-term cost of President Bush's tax cuts look smaller than it is. "More than half of the current AMT problem is due to the effects of the 2001 and 2003 tax cuts, which [will have] pushed millions more taxpayers onto the AMT and more than doubled the amount of tax owed under the AMT [without a patch]," notes Aviva Aron-Dine, a policy analyst at the Center on Budget and Policy Priorities.

The tax cuts make you more susceptible to the AMT because they lower your regular tax liability and you're supposed to compare your regular tax liability to that under AMT and pay the higher of the two.

Even if a patch for 2007 is put in place, nearly 2 million of the 3.8 million taxpayers who will get hit will be paying the AMT because of the tax cuts, according to Tax Policy Center estimates.

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