AMT: Middle-class more at risk than millionaires

NEW YORK (CNNMoney.com) -- Middle-income taxpayers have become more vulnerable than millionaires to the alternative minimum tax, which was originally designed to prevent tax avoidance by the rich, according to testimony given Wednesday before a House panel.

"Because of poor design, millionaires are actually less likely to owe AMT than middle-income people with kids," Tax Policy Center Director Len Burman told the House Ways and Means Select Revenue Measures Subcommittee.

There are a few reasons.

For starters, the AMT doesn't allow for personal exemptions, the standard deduction or a host of other tax breaks that middle-income families enjoy under the regular code. So your taxable income looks greater under the AMT than it does under the regular code - and you owe whichever tax bill is higher.

Live in a high-tax state? Under the regular code, you can deduct state and local taxes from your liability but not when doing the AMT calculation. National Taxpayer Advocate Nina Olson told lawmakers that 68 percent of all the income AMT taxpayers had to add back is the result of that disallowance.

Have kids? Under the regular code, the more you have the more personal exemptions you may take but not under the AMT. Olson says that 19 percent of the income AMT taxpayers had to add back is the result of the disallowance of personal exemptions.

"Today, the AMT affects millions of taxpayers with no tax-avoidance motives at all - unless one considers choosing to live in a high-tax state or choosing to have children to be a tax-avoidance motive. ... If I could make just one change to the federal tax code, I'd use it to eliminate the AMT," Olson said.

Second, the income-exemption levels are too low. In calculating AMT liability, a portion of income is exempt, but exemption levels have not kept pace with inflation - even though the average paycheck has.

In 1969, the exemption for everyone was $30,000, which adjusted for inflation is $165,000 today, said Olson. But under current law, the levels are just $45,000 for joint filers and $33,750 for single filers. Lawmakers have been passing annual "patches" to increase them, but they are nowhere near $165,000.

Third, millionaires with a lot of investment income from tax shelters are less susceptible to the AMT because their capital gains and dividends are taxed the same way as they are under the regular code - at a lower rate than ordinary income, Burman noted.

Last, Burman and others at the House panel hearing said that the tax cuts enacted in 2001 and 2003 will double the number of people subject to the AMT unless lawmakers act to reform the tax.

That's because the tax cuts lower tax liability under the regular code, forcing some to pay the higher AMT bill. Without the tax cuts, the number of taxpayers subject to the AMT would already be high - 16 million by 2010 - unless the income exemption levels were indexed to inflation. But with the tax cuts, that number doubles to 32 million.

"Cutting the regular income tax without fixing the AMT at the same time is the tax policy equivalent of throwing gasoline on a fire," Burman said.

But research from the Tax Policy Center indicates that if you're pushed into the AMT as a result of the tax cuts, your tax bill would still be lower or about the same as what you would have owed both under the AMT or the regular code had the tax cuts not been enacted. (For more on this, see Money Magazine Senior Editor Pat Regnier's blog, Generation Risk.)

Nevertheless, Burman told lawmakers, extending the tax cuts past 2010 - as President Bush and others would like to do - doubles the cost of fixing the AMT over 10 years.

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