The looming alternative minimum tax debacle

The Tax Policy Center (TPC) has estimated that going over the fiscal cliff will raise taxes on average by about $3,500 per household in tax year 2013, compared with extension of 2011 tax law. But tens of millions of Americans have a much more immediate problem. They’ll face a huge tax increase when they file their 2012 tax returns early next year. And many of them don’t even know it.

The trouble: A number of major tax benefits expired earlier this year, including the deductibility of state and local sales taxes as well as many business incentives. But by far the biggest problem comes from the expiration of the temporary increase in exemption levels under the alternative minimum tax (the “AMT patch”).

In 2011, the exempt income levels under the AMT were $48,450 for single taxpayers and $74,450 for married taxpayers. If Congress fails to act, these exemptions will decline to $33,750 for singles and $45,000 for couples. As a result, 28 million more taxpayers will be hit by the AMT, and many of the 4 million who would owe AMT even with a patch will owe even more.  

Overall, AMT liability will rise from $34 billion to $120 billion. Of that $86 billion increase, new AMT taxpayers will owe $64 billion—an average of about $2,250–while those currently on the tax will pay another $22 billion—an increase of about $5,500 each over the nearly $8,500 average they would pay with a patch. 

If you suspect that a tax that affects 32 million households is not limited to the rich, you are right. It is true the enhanced AMT will hit upper middle-income taxpayers the hardest – 98 percent of those with adjusted gross income between $200,000 and $500,000 will pay an average of almost $11,000 in AMT on top of their regular tax liability.

But taxpayers with more modest incomes won’t be spared. About 88 percent of taxpayers with incomes between $100,000 and $200,000 will pay an average AMT of over $3,100, while 61 percent with incomes between $75,000 and $100,000 will be hit with AMT liabilities averaging nearly $1,500. Even many making between $50,000 and $75,000 will get hit: About 22 percent will have to cough up an average additional tax of more than $1,100.

To make matters worse, many of these taxpayers have no idea they will owe this extra tax when they file their 2012 returns.  Withholding schedules for 2012 did not reflect the expiration of the patch and it is a safe bet that few taxpayers factored it into their estimated payments for tax year 2012. One can hope that underpayment penalties will not be assessed on AMT taxpayers who paid too little withholding and estimated tax this year.  But even without penalties, an extra $1,000 or more in unanticipated liability in April will be a cruel hit on many middle-income families.

I wish I could end this post here. But the damage goes beyond those who will pay more taxes. The unpatched AMT includes complex rules for reducing certain tax credits and deductions under the regular tax if these benefits would otherwise make a taxpayer subject to AMT. IRS has designed its systems under the assumption that Congress would patch the AMT for tax year 2012 and will need to make extensive changes absent a patch. As a result, IRS estimates that over 60 million taxpayers, nearly half of all individual tax filers, may not be able to file their 2012 returns until March or later. So even if you won’t owe more tax this spring, your refund may be delayed for months.

Those lawmakers who seem willing to drive us over the cliff should consider how their failure to fix the AMT would affect millions of Americans. They are going to need a good story to tell taxpayers whose refunds will be delayed and a better one to tell those who will owe thousands of dollars more in taxes come April.