AMT: Popular tax breaks in the cross hairs
The knotty issue of how to 'fix' the AMT is high on the House's agenda this summer. Here are some revenue raisers that may be considered.
NEW YORK (CNNMoney.com) -- House lawmakers plan to consider fixes for the Alternative Minimum Tax (AMT) this summer, and the debate on how to pay for reform is sure to get heated.
The issue is complicated because there will be a push to make any tax changes "revenue-neutral," and there aren't a lot of ways to replace the between $500 billion and $1 trillion AMT is projected to generate during the next 10 years.
"There are very few things you can dial up or down ... In the end, something controversial will have to be done," said Clint Stretch, managing principal of tax policy at Deloitte Tax LLP.
The AMT, originally intended to ensure the wealthy didn't shelter too much of their income from tax, hasn't kept pace with the times since its inception almost 40 years ago. Consequently, 23 million mostly middle- and upper-middle-income taxpayers this year and more than 30 million by 2010 will be subject to the AMT, which results in a higher tax bill than under the regular federal income tax code.
Though ultimate adoption of reform is likely a long way off, here are the ideas that may be brought up on the House floor this summer:
Add a surtax
The Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution, recently proposed repealing the AMT.
To pay for it, high-income filers would pay a 4 percent surtax on adjusted gross income above $100,000 ($200,000 for joint-filers).
That's an extra $2,000 if you're married with AGI of $250,000.
Still, the majority of taxpayers with AGIs under $500,000 would pay less than under current law, the Center estimates.
Increase AMT rates
In April, Democratic tax writers in the House were said to have broadly agreed on a proposal to exempt taxpayers from having to pay AMT if their incomes are below $250,000, while increasing the AMT liability of those earning more than $500,000 and reducing the AMT liability of those with incomes in between.
The Tax Policy Center estimated that excluding joint filers with incomes under $250,000 could mean a tax cut for 66 percent of taxpayers in the top 10 percent of the income distribution.
But if that were implemented and the lost AMT revenue were replaced, the Center estimated that lawmakers would have to raise the AMT rate to 35 percent from the current 26 percent and 28 percent rates. That would result in an average tax increase of almost 8 percent - or $30,303 - for the top 1 percent of taxpayers.
Increase capital gains rate
Currently, capital gains are taxed at the same rate (currently 15 percent) under AMT as they are under the regular tax code.
Some have suggested raising the AMT capital gains rate as high as 28 percent, but that's not as likely to be politically viable given how much the Bush administration and other lawmakers want to preserve the capital gains cuts put into effect since 2001 and how many Democrats and Republicans want to offer incentives to encourage investment.
Repeal the state and local tax deduction
House Ways and Means Chairman Charles Rangel (D-NY) has said that in paying for AMT reform or other tax changes he wants lawmakers to put all tax benefits on the table for review to see if they still make sense.
That includes the state and local tax deduction.
Repealing the state and local tax deduction could make up for the revenue loss of full AMT repeal and even allow for a 2 percent reduction in all income tax rates assuming President Bush's tax cuts expire after 2010, according to estimates from the Tax Policy Center.
Some tax experts believe it's an unfair preference, since it disproportionately benefits those who live in high-tax states.
The Tax Foundation, which is critical of many tax preferences and would prefer a flat tax, notes that the deduction has the perverse effect of subjecting middle- and upper-middle-income families in high-tax states to the AMT.
The reason: The AMT disallows the deduction, making it more likely a family's tax liability under AMT will be higher than it is under the regular tax code. And by law, taxpayers are supposed to pay the higher of the two bills.
Change the mortgage deduction
Another deduction that may draw interest in the AMT reform debate is the mortgage interest deduction
Though it can only be taken by the third of taxpayers who itemize and is of greatest value to high-income homeowners, it still is a popular break and lawmakers would have to tread carefully.
But a reduced mortgage tax break available to all taxpayers rather than just itemizers might be a more palatable change.
Although not given in the context of paying for AMT reform, the president's tax reform panel in 2005 recommended lowering the mortgage-interest cap - the amount of a loan on which homeowners could deduct interest - and converting the deduction to a credit equal to 15 percent of interest paid on mortgages.
Unlike a deduction, all homeowners could take the credit, which is a dollar-for-dollar reduction of the taxes you owe. A deduction, by contrast, reduces your taxable income by a percentage equal to your top tax rate.
Long, hot summer, even longer fall?
The House debate is far from the final word on AMT reform. If it passes a bill this summer, the path through the Senate could be rocky given the disagreements on the issue between and within both parties.
"The House will be dropping a penny down a very deep well and may not hear it hit," Stretch said.
Greg Valliere, chief strategist of the Stanford Washington Research Group, predicts that major AMT legislation won't happen before 2009 and wouldn't take effect before Jan. 1, 2010.