ALTERNATIVE

MINIMUM TAX

Overview of Its

Rationale and Impact on

Individual Taxpayers

Statement of James R. White

Director, Tax Issues

United States General Accounting Office

GAO Testimony

Before the Committee on Finance,

United States Senate

For Release on Delivery

Expected at

10:00 a.m. EST

on Thursday

March 8, 2001

GAO-01-500T
1

Chairman Grassley, Ranking Member Baucus and Members of the Committee

I am pleased to participate in the Committee's hearing on family tax relief. My statement

focuses on the Alternative Minimum Tax (AMT), its interaction with the regular tax

system, and its projected growth in coverage. In summary, my statement makes the

following points:

• AMT was designed to ensure that high-income individuals do not avoid significant

income tax liabilities--for tax year 1997, about 14,000 taxpayers would not have paid

any income taxes absent AMT.

• AMT operates as a separate tax system that parallels the regular individual income

tax system but with different rules for determining taxable income, different tax rates

for computing tax liability, and different rules for allowing the use of tax credits.

• AMT affected about 1 percent of taxpayers in 2000 and accounted for about $5.8

billion in additional tax revenue; by 2010, it is expected to increase the tax liabilities

of about one out of six taxpayers and account for about $189 billion in tax revenues

over the period.

• The projected increase in AMT coverage is, for the most part, attributable to inflation

(the regular tax system is indexed for inflation, but the AMT is not) and to the

scheduled expiration of legislation temporarily excluding some tax credits (such as

child tax credits) from AMT rules.

• AMT's impacts include increased taxpayer compliance burden; increased IRS

administrative cost; redistribution of the tax burden among taxpayers; changed

economic incentives; and the potential to neutralize, for some taxpayers, changes to

the tax system.

My testimony today is based on our August 2000 report to the Committee.1

RATIONALE FOR ESTABLISHING AMT

AMT was created to reduce the ability of high-income individuals to escape payment of

tax on income by using tax preferences available under the regular tax system. A type of

minimum tax was first enacted in 1969, following congressional testimony by the

Secretary of the Treasury reporting that 155 individuals, each with adjusted gross income

above $200,000 (about $1.1 million in fiscal year 2000 dollars), paid no federal income tax

in 1966.

Over the intervening years, the minimum tax has been amended a number of times,

producing today’s AMT. Although the mechanics of AMT were periodically modified, the

objective of limiting high-income taxpayers' ability to avoid significant tax liability by

using tax preferences was retained.2

 According to recent IRS calculations, about 14,000

taxpayers would not have had any individual income tax liability absent AMT in tax year

1997.

 1

 See Alternative Minimum Tax: An Overview of Its Rationale and Impact on Individual Taxpayers (GAO/GGD-00-180, Aug. 15, 2000). 2

 See S. Rept. No. 313, 99th Cong., 2d sess., p.520.
2

HOW AMT WORKS

In general, AMT is a separate tax system that parallels the regular individual income tax

system. It generates an alternative tax liability by

• applying different tax rates to a broader base of income than the regular individual

income tax system does and

• limiting the use of certain tax credits available under the regular income tax.

As illustrated in figure 1, taxpayers complete a series of steps to determine if they are

affected by AMT.3

First, Taxpayers Calculate Their

Regular Tax Liability.

As the first step in the process, taxpayers calculate their tax liability based on their

taxable income under the regular income tax. To determine taxable income,4 taxpayers

add up their various items of income, such as salaries, interest, and dividends, and then

• subtract certain allowable items, such as moving expenses and alimony, to compute

Adjusted Gross Income (AGI);5

• subtract the standard or itemized deductions, such as home mortgage interest,6 and

• subtract personal exemptions.7

Next, taxpayers determine their regular tax liability by applying the appropriate tax rates

to this taxable income amount. The regular individual income tax has five marginal tax

rates: 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent for tax year 2000.8

The regular income tax also provides special tax rates for long-term capital gains.

 3

 This illustration generally applies to individual taxpayers required to file IRS Form 1040, U.S. Individual Income Tax Return. See

appendix I for a few illustrations on how individual taxpayers may have their taxes increased by AMT in 2000.

4

 Generally, all income is subject to tax; however, some types of income are excluded, such as interest on tax-exempt bonds.

5

 Deductions for determining AGI are certain items that are specifically exempt or excluded from gross income by statute, such as the

deduction for IRA contributions, moving expenses, and alimony.

6

 In 2000, the standard deduction was $4,400 for single filers; $6,450 for heads of household; $7,350 for married, filing jointly; $3,675

for married, filing separately.

7

 Personal exemptions are based on the number of dependents claimed by a taxpayer. In 2000, personal exemptions were $2,800 for

each qualifying exemption, subject to phase-outs based on taxpayer income.

8

 In computing a taxpayer's tax liability, the tax rates are applied to varying levels of taxpayer income according to the taxpayer's

filing status. For example, the tax for married taxpayers filing jointly is 15 percent of the first $43,850 in taxable income; $6,577.50

plus 28 percent of taxable income between $43,850 and$105,950; $23,965.50 plus 31 percent of taxable income between $105,950 and

$161,450; $41,170.50 plus 36 percent of taxable income between $161,450 and $288,350; and $86,854.50 plus 39.6 percent of taxable

income over $288,350.
3

Figure 1: Simplified Illustration of Regular Income Tax and AMT

Exclusions and deductions for AGI

Standard or itemized deductions

Personal exemptions

Regular taxable income

Regular tax rates

Regular tax liability (before credits)

Tax credits

Regular tax liability

Step 1: Calculate Regular Tax Liability

Income

No Yes

Does AMT apply?

Otherwise, complete preliminary 

AMT worksheet.

Go to

Step 3.

Step 2: Determine If AMT Applies

Stop and pay

regular tax.

If claiming tax credits that are

limited by AMT, go directly to

Step 3 .

If claiming certain exclusions or

deductions that require adjustments

under AMT rules go directly to Step 3.

Calculate AMT Liability

Personal exemptions

Standard or AMT adjusted

itemized deductions

AMT adjustments and preferences

AMT exemption

AMT taxable income

AMT tax rates

AMT liability

Regular taxable income

Step 3:

Pay AMT amount 

less allowable

tax credits.

Pay regular tax

less allowable

tax credits.

Step 4: Compare Tax Liabilities

No Yes

Is AMT > regular tax,

(before tax credits)?

A

Source: GAO Analysis.

Last, taxpayers may reduce their regular tax liability with certain tax credits unless

limited by AMT rules. Taxpayers with credits limited by AMT, such as the low income

housing tax credit, are required to go to step 3 in figure 1, bypassing step 2, in order to

determine the extent to which AMT limits apply. Under current law, taxpayers generally

may not use certain tax credits, most notably the general business credit, to reduce their

regular tax liability to an amount less than their AMT. For such taxpayers, AMT serves as

a floor for the regular income tax below which allowable credits are disallowed but may
4

be carried over to another tax year. Under current law, however, personal tax credits,

such as the child and education credits, are not limited by AMT rules through 2001.

However, beginning in 2002, taxpayer use of these credits to reduce their tax liability

would be limited by AMT.

Second, Taxpayers Determine

Whether AMT Applies

As the second step, taxpayers determine whether they may be subject to AMT as follows.

• Taxpayers who claim certain AMT preference items under the regular income tax

that are considered AMT adjustments or preferences (for example, percentage

depletion or intangible drilling costs) are automatically subject to the AMT rules and

are to proceed directly to step 3—calculate AMT liability.9

• Other taxpayers are to complete a worksheet that contains a series of income tests

designed to determine whether a taxpayer’s income exceeds a preliminary threshold

according to the basic AMT rules.10

If the worksheet shows that their income exceeds the threshold, taxpayers must

continue to step 3—calculate AMT liability. If the worksheet shows that their income

does not exceed the threshold, taxpayers pay their regular tax liability without having to

complete steps 3 and 4 in figure 1.

Third, Some Taxpayers

Calculate AMT Liability

As the third step, taxpayers subject to AMT compute their AMT liability using the AMT

form,11 which requires them to recalculate their taxable income and tax liability using

rules that differ from the regular income tax rules. To calculate taxable income under

AMT, taxpayers essentially start with the taxable income amount reported under the

regular system and then do the following:

Add back their personal exemptions that were allowed under the

regular income tax.

Add back the standard or certain AMT-adjusted itemized deductions that were

allowed under the regular income tax. AMT requires taxpayers to adjust certain

itemized deductions taken under the regular income tax. For example, AMT disallows

the deduction for state and local taxes and allows only for the deduction of medical

expenses above 10 percent of AGI.12 However, AMT does not disallow or adjust all

 9

 See appendix I of GAO/GGD-00-180, Aug. 15, 2000. The appendix identifies the items that automatically subject taxpayers to the

AMT rules in step 2 of figure 1.

10 The worksheet is provided in the instructions to IRS forms 1040 and 1040A.

11 The AMT form is IRS Form 6251, the Alternative Minimum Tax-Individuals. This form, when necessary, is to be attached to IRS

Form 1040, U.S. Individual Income Tax Return.

12 Under the regular income tax, deductions are allowed for medical expenses in excess of 7.5 percent of AGI.
5

itemized deductions. For example, AMT does not require taxpayers to add back certain

mortgage interest or charitable contribution deductions to their taxable income.13

Add other, non-itemized, AMT adjustments and preference items taken under

the regular income tax. AMT disallows certain non-itemized preference items and

requires adjustments to other non-itemized deductions available under the regular

income tax, including some income excluded from the regular income tax. Many of

these items are related to timing of deductions allowed for certain types of business

investments. In effect, the elimination or adjustment of certain preference items expands

the base of taxable income under AMT.14

Subtract the AMT exemption amount based on filing status. The AMT exemption

amount ($45,000 for joint filers), is generally intended to replace the personal

exemptions and the standard deduction allowed under the regular income tax. The AMT

exemption is subject to a phase out based on taxpayer income15 and is not adjusted to

account for family size.

Taxpayers then calculate their AMT liability by applying the AMT tax rates to

their AMT taxable income. The AMT applies a 26-percent tax rate on the first $175,000

of AMT taxable income and 28 percent of such income in excess of $175,000.16

Fourth, Taxpayers Compare Tax

Liabilities and Check the Use of

Certain Tax Credits

As the fourth step, taxpayers essentially compare their regular tax liability (before

credits) with their AMT liability, as shown in step 4 of figure 1. In general, if their AMT

liability is greater than their regular tax liability (before credits), they must pay their

AMT liability less any allowable credits. If their AMT liability is less than their regular tax

liability (before credits), they pay their regular tax liability less any allowable credits.17

Currently, the AMT rules temporarily allow taxpayers to use personal credits without

limitation.18 However, taxpayers generally may not use general business credits to reduce

their regular tax liability to an amount less than their tax liability computed under the

AMT rules. Also, taxpayers whose AMT liability exceeds their regular tax liability may

 13 See appendix I of GAO/GGD-00-180, Aug. 15, 2000 for more details.

14 Ibid.

15 The $45,000 exemption amount is subject to a phase-out of 25 percent of AMT taxable income in excess of $150,000. The AMT

exemption for single and head of household filers is $33,750, subject to a phase-out of 25 percent for taxable income in excess of

$112,500. The AMT exemption amount for married individuals filing separately is $22,500, subject to a phase-out of 25 percent of

taxable income in excess of $75,000.

16 For married taxpayers filing separately, AMT applies the 26-percent tax rate to the first $87,500 of AMT taxable income and the 28-

percent rate on the excess. AMT also has special rules for taxing capital gains income, which generally preserve the lower capital

gains tax rates of the regular tax system (e.g., 20-percent tax rate).

17 The foreign tax credit can also be deducted from AMT., but it may not reduce AMT by more than 90 percent. Additionally, taxpayers

may be able to use part of their AMT liability, if applicable, to offset their regular tax liability in the following year. Commonly

referred to as the “AMT credit,” this credit is subject to restrictive conditions, and few taxpayers are eligible for it. 18 The Omnibus Consolidated and Emergency Supplemental Appropriations Act of 1998 allowed taxpayers to claim their personal

credits—including the child and education credits—in full against their AMT liability for the tax year beginning after December 31,

1997. The Ticket to Work and Work Incentives Improvement Act of 1999 extended that provision through 2001.
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not use certain refundable tax credits (e.g., the earned income tax credit) to reduce their

AMT liability to an amount less than their tax liability computed under the regular tax.

PROJECTED INCREASES IN AMT

COVERAGE AND TAX LIABILITY

Currently, according to recent research at Joint Committee on Taxation (JCT) and

Treasury, AMT affects relatively few taxpayers and generates a relatively small portion of

additional tax liability.19 For 2000, Treasury research indicates that about 1.3 million

taxpayers—about 1.3 percent of all taxable returns—would have to remit more in tax

than they would otherwise. Their additional tax liability was estimated at about $5.8

billion.

By 2010, however, AMT coverage and tax liabilities are projected to increase

dramatically. (See fig. 2 for trends.) Recent research at Treasury estimated that:

• The number of taxpayers affected by AMT under current law is projected to expand

from about 1.3 million in 2000 to about 17 million in 2010—a 31 percent average

increase per year. By 2010, AMT is expected to affect 16 percent of all taxable

returns filed by individuals, up from about 1.3 percent in 2000.

• The corresponding additional AMT liability is projected to increase from about $5.8

billion to about $38.2 billion from 2000 to 2010--a 21 percent average increase per

year--for a total increase of $189 billion over this period.

 19 For reporting purposes, we used data estimates from recent research conducted at the Department of the Treasury’s Office of Tax

Analysis. See Robert Rebelein and Jerry Tempalski, Who Pays the Individual AMT?, Office of Tax Analysis Working Paper 87 (June

2000). All estimates in this paper were made using the Treasury Department’s Individual Tax Model in combination with the

administration’s economic forecast from the FY 2001 Budget. This working paper notes that the views expressed in the paper do not

necessarily represent official Treasury positions. Accordingly, we limited our use of the paper to the data produced by the Treasury

models and refer to the working paper as recent research at Treasury. Also, JCT provided us with updated tables from its report,

Present Law and Background Relating to the Marriage Tax Penalty, Education Tax Incentives, the Alternative Minimum Tax, and

Expiring Tax Provisions (JCX-39-99).
7

Figure 2: Actual and Projected Number of Taxpayers Affected Financially by AMT

Source: Department of the Treasury, Office of Tax Analysis Working Paper 87 (June 2000)

The additional tax liability generated by AMT has two components.

• The additional tax liability generated from individuals with direct AMT liabilities is

projected to increase from $3.4 billion in 2000 to $26.4 billion in 2010. The number of

affected individuals is projected to increase from 1.2 million in 2000 to 12.5 million in

2010.

• The additional tax liability generated from individuals with credits lost due to AMT is

projected to increase from $2.4 billion in 2000 to $11.8 billion in 2010. The number of

individuals affected by the loss of credits is projected to increase from 200,000 in

2000 to 9.4 million in 2010. Of this increase, about 4.9 million of the 9.4 million

taxpayers were expected to incur both a direct AMT tax liability and a reduction in

their ability to use tax credits.

REASONS FOR THE AMT INCREASES

The projected increase in AMT coverage is, for the most part, attributable to inflation

(the regular tax system is indexed for inflation but the AMT is not) and to the scheduled

expiration of legislation temporarily excluding some tax credits (such as child tax

credits) from AMT rules.
8

AMT Is Not Indexed for Inflation

In the regular income tax system, the personal exemptions, standard deduction, and tax

rate brackets increase based on inflation. Under AMT, however, the exemption amounts,

the threshold phase-out amounts for these exemption amounts, and the AMT rate

brackets remain constant.

The lack of inflation indexing in AMT causes taxpayers’ AMT liabilities to increase faster

than their regular tax liabilities. Real income growth—growth above inflation—will

increase both regular tax and AMT liabilities. However, under the regular tax system,

income growth due to inflation will generally not increase regular tax liabilities as a

percentage of income because income is increasing at the same rate, but it will increase

AMT liabilities as a percentage of income. The result is that over time, more taxpayers

will have an AMT liability that exceeds their regular tax liability as long as there is

inflation.

If the AMT parameters were indexed to account for inflation starting in 2000, according

to recent research at Treasury (illustrated in fig. 2), the projected number of taxpayers

affected financially by AMT over time would be relatively constant and significantly less

than under current law.20 The number of individuals affected by an inflation-adjusted

AMT is estimated at 2.1 million in 2010 compared to 17 million under current law.

Increases Attributable to Expiration of Tax Credit Legislation

In 2001, legislation that was enacted to temporarily exclude personal credits from

limitation under the AMT rules is scheduled to expire.21 Recent research at Treasury

estimated that the number of taxpayers with reduced credits would increase from

200,000 in 2001 (the last year of the personal credits exclusion) to 2 million in 2002 and

would rise to 9.4 million in 2010. According to JCT, the recently enacted child and

education credits are expected to be affected the most.22

If personal tax credits were permanently excluded from the AMT rules, the projected

number of taxpayers affected financially by AMT and the corresponding revenue

generated would also be lower than under current law.23 As figure 2 shows, recent

research at Treasury estimated that under this scenario, about 13.4 million taxpayers

would be affected by AMT in 2010 compared to 17 million under current law.

AMT HAS A NUMBER OF IMPACTS

AMT has a number of impacts, including increased compliance burden on taxpayers;

increased administrative costs on IRS; redistribution of the tax burden among taxpayers;

changed economic incentives in the tax system; and the potential to neutralize, for some

 20 Under this scenario, personal tax credits would be limited by the AMT rules beginning in 2002.

21 See footnote 18.

22 The Child Credit, the HOPE education credit, and the Lifetime Learning Credit are provisions of the regular income tax that were

enacted in the Taxpayer Relief Act of 1997.

23 This scenario does not include inflation adjustments for the AMT parameters.
9

taxpayers, changes to the tax system. The projected growth in AMT coverage would

amplify these impacts.

Taxpayer Compliance Burden

Although it is difficult to concretely measure compliance burden, there is common

agreement that AMT can significantly complicate the filing situation for taxpayers. The

National Taxpayer Advocate ranks AMT as one of the most burdensome areas of tax

law.24

A significant portion of AMT compliance burden is attributable to the complexity of the

AMT rules. AMT requires taxpayers to compute their regular tax liability and then

recompute their AMT liability using a different base of income, different exemptions, and

different tax rates. AMT also applies different treatments to certain income deductions,

exclusions, and credits that may be used by taxpayers under the regular income tax. As a

result, affected taxpayers are required to apply two methods of accounting to some of

these items–one for the regular tax and one for AMT.

According to IRS and Treasury officials, the complexity of calculating AMT liability can

be most problematic for married taxpayers who consider filing separately. AMT, like the

regular tax, establishes procedures that are intended to minimize or eliminate that ability

of some taxpayers to allocate income arbitrarily between spouses to reduce their tax

liability. If married taxpayers were to follow all recommended procedures, they would

have to compute their taxes four different ways. First, they would need to compute their

regular tax as if they were filing jointly and then again as if filing separately. Then they

would need to determine their AMT tax as if filing jointly and then again as if they were

filing separately. From these computations, the taxpayers could then determine which

filing method would be most appropriate for them.

IRS Administrative Costs

The complexity of AMT and increases in the number of taxpayers affected also would

complicate IRS’ efforts to administer the federal tax system. According to IRS, AMT is

more than just an add-on to the existing tax system. AMT involves much more than just

annually processing the AMT returns filed by taxpayers such as computer-checking

calculations on the returns and crediting the taxpayers' accounts with the payments.

Some aspects of compliance with AMT rules can be verified only through office or field

audits. According to IRS, the frontline employees who do such verification work

consistently rank AMT as one of the most complex provisions with which they deal.

Redistribution of Tax Burden

As shown in figures 3 and 4, recent research at Treasury indicated that AMT coverage,

absent any legislative change, will shift from mostly higher income taxpayers in 2000 to

increasingly more middle-income taxpayers by 2010.

 24 FY 1999 National Taxpayer Advocate’s Annual Report to Congress, IRS Publication 2104 (Rev.12-99).
10

The recent research at Treasury provides some additional insight into the shift in the

classes of taxpayers affected by AMT. In 2000, the taxpayers projected to be affected by

AMT are more likely to be higher income families with many dependents. By 2010,

increasingly more middle-income, moderately sized families are expected to be affected

by AMT. For example, the percentage of taxpayers affected by AMT with incomes

between $50,000 and $75,000 and four personal exemptions is projected to increase from

about 1 percent in 2000 to 32 percent in 2010. The primary reason for this change is that

for middle income taxpayers, personal exemptions are projected to be the largest and

most common items to be added back into taxable income under AMT.

Additionally, the state where a taxpayer lives also affects AMT coverage. The

projections indicate that taxpayers living in states with high income and property taxes

are more likely to be affected by AMT than those in states with low income and property

taxes. The apparent driving factor for this change is that state and local taxes are

projected to amount to about one-half of the total preference items that are added back

into the taxable income for computing AMT tax liability in 2010. (See app. II for

additional information on the proportion of AMT taxpayers by state of residence.)

Figure 3: Distribution of the Number of Taxpayers Financially Affected by AMT

Note: Adjusted gross income is in constant 2000 dollars.

Source: Department of the Treasury, Office of Tax Analysis Working Paper 87 (June 2000)

Number of AMT

Taxpayers (in millions)

Numbers of AMT

Taxpayers (in millions)

7.5 7 6.5 6 5.5 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5

Less than $0

$0 - $14,999

$30,000 - $49,999

$50,000 - $74,999

$75,000 - $99,999

$100,000 - $199,999

$200,000 or more

$15,000 - $29,999

2000 Adjusted gross income 2010
11

Figure 4: Distribution of the Additional AMT Tax Liability

Note: Adjusted gross income is in constant 2000 dollars.

Source: Department of the Treasury, Office of Tax Analysis Working Paper 87 (June 2000)

Changed Economic Incentives

Through its different definition of taxable income and tax rate structure, AMT may affect

the economic incentives created by the regular income tax.25 If AMT coverage increases

over the next 10 years as projected, more taxpayers will face those affected incentives.

Two examples follow.

• According to JCT, AMT adjustments, preference items, and credit limitations may

reduce incentives for taxpayers to undertake certain investments and activities that

are favored under the regular tax. For example, unincorporated business owners’

incentives to invest may be reduced because AMT rules regarding depreciation are

less generous than under the regular tax. Also, if education credits become limited by

AMT because the moratorium on the use of personal credits expires, taxpayers may

have less incentive to pursue educational opportunities that qualify for these credits.

• Additionally, the current 26- and 28-percent tax rates under AMT are generally lower

than the tax rates a taxpayer faces under the regular tax. Lower marginal tax rates—

the additional tax owed from earning an additional dollar of income—decrease the

disincentives taxpayers face to work additional hours or invest additional amounts.

The extent to which the incentives and disincentives affected by AMT lead to changes

in taxpayer behavior and changes in overall economic performance is uncertain.

 25 For discussions of the effects of AMT on economic efficiency, see Joint Committee on Taxation, Present Law and Issues Relating to

the Individual Alternative Minimum Tax (“AMT”) (JCX-3-98), Feb.2, 1998, and Michael J. Graetz and Emil Sunley, “Minimum Taxes

and Comprehensive Tax Reform,” in Henry J. Aaron, Harvey Galper, and Joseph A. Pechman, eds., Uneasy Compromise: Problems of

a Hybrid Income-Consumption Tax (Washington, D.C.: The Brookings Institution, 1988).

Less than $0

$0 - $14,999

$30,000 - $49,999

$50,000 - $74,999

$75,000 - $99,999

$100,000 - $199,999

$200,000 or more

$15,000 - $29,999

Adjusted gross income

16 14 12 10 8 6 4 2 0 0 2 4 6 8 10 12 14 16

AMT liability (in billions) AMT liability (in billions)

2000 2010
12

Impact on Changes to the Regular Tax

For some taxpayers, AMT has the potential to neutralize future tax changes designed to

provide tax relief in the regular tax system. As I mentioned before, AMT is a parallel tax

system that imposes higher taxes on taxpayers who have higher AMT liabilities than

regular tax liabilities. Thus, taxpayers who are already subject to AMT would not benefit

from reductions in their regular income tax.26

Additionally, some taxpayers who pay the regular tax may not receive the full benefits of

cuts in their regular tax. Tax reduction legislation could reduce the taxes for some

individuals below the level of taxes that would be due under AMT rules.

This concludes my statement. I would be pleased to take any questions you may have.

 26 Similarly, tax changes that increase regular taxes would not affect those AMT taxpayers whose AMT liability already exceeded the

regular tax increase.
13

Appendix I

Illustrations Depicting How Individual Taxpayers May Have Their Taxes

Increased by AMT in 200027

Illustration 1: A large family (husband, wife, and six children) had wage earnings of

$80,000 in 2000. In filing their 2000 tax return, the family would not benefit from

itemizing deductions because they rented a house and had no other significant tax

deductions. The family was eligible to take the standard deduction, personal exemptions,

and child tax credit. Under the regular income tax, the family's tax liability would be

$5,377 ($8,377 in income tax less a $3,000 child tax credit), or about 11 percent of their

$50,250 taxable income ($80,000 in wages less the standard deduction of $7,350 and

personal exemptions of $22,400).

Under current tax law, AMT would cause this family's tax liability to increase 13 percent

above its tax liability under the regular income tax. After computing AMT, the family's

tax liability would be $6,100 ($9,100 in taxes less $3,000 child tax credit). The $9,100 tax

liability results from AMT tax rules that require the family to recompute taxable income

(essentially add back the standard deduction and personal exemptions to taxable income

computed under the regular tax), then reduce that taxable income by a $45,000

exemption amount and then apply a 26-percent tax rate to the remainder.

Illustration 2: A retired couple, age 65, received taxable pension income totaling

$80,000, interest and dividends of $10,000, and distributed capital gains totaling $125,000

from mutual fund investment in technology stocks in 2000. In filing their 2000 tax return,

the couple would not benefit from itemizing deductions because they had paid off the

mortgage on their house and had no other significant deductions. Under the regular

income tax, the couple's tax liability would be $40,685 or about 20 percent of their

$201,358 taxable income ($80,000 in taxable pension income, $10,000 interest and

dividends, and $125,000 in capital gains less a standard deduction of $9,050 and personal

exemptions of $4,592).

Under current tax law, AMT would cause this couple's tax liability to increase about 1

percent above its tax liability under the regular income tax. After computing AMT, the

couple's tax liability would be about $40,925. The $40,925 tax liability results from AMT

tax rules that require the couple to recompute taxable income (essentially, add back the

standard deduction and personal exemptions to taxable income computed under the

regular tax), then reducing that amount by a $45,000 exemption amount (adjusted down

to $28,750 because of the extent to which the couple's income exceeded the applicable

$150,000 threshold for full use of the exemption). To this residual amount, AMT provides

for applying a 20-percent rate to income attributable to capital gains and 26 percent to

the remainder.

 27 These illustrations are based on three hypothetical taxpayers. The extent to which AMT affects any individual taxpayer depends on

the taxpayer's unique characteristics.
14

Illustration 3: A four-member family (husband, wife, and two children) had income

totaling $265,000 in 2000, comprised of wage earnings totaling $190,000, interest and

dividend earnings of $17,000, and long-term capital gains of $58,000. Given the nature of

the family's expenditures, the family would benefit from itemizing their deductions when

filing their 2000 tax return. Their itemized deductions would include $23,000 for state

and local income taxes and property taxes, $16,000 for home mortgage interest, and

$6,000 for charitable gifts. Additionally, they are eligible to deduct $4,704 for personal

exemptions. Given the amount of their income, the regular tax rules limit the family's

itemized deductions and personal exemptions to $45,622. Under the regular income tax,

the family's tax liability would be $52,748, or about 24 percent of its taxable income of

$219,378.

Under current tax law, AMT would cause this family's tax liability to increase about 2

percent above its tax liability under the regular income tax. Under AMT rules, the

family's tax liability would be about $54,045 on income of $221,250 (alternative minimum

taxable income of $243,000 less a $45,000 exemption amount reduced to $21,750 because

of the extent to which family income exceeded the applicable $150,000 threshold for full

use of the exemption). Under AMT rules, a 20-percent rate was then applied to income

attributable to capital gains and 26 percent to the remainder.
15

Appendix II

AMT Taxpayers and State of Residence

Under the regular income tax, but not AMT, taxpayers who itemize deductions are

allowed to reduce their tax liability by deducting from their income the amounts paid to

state and local governments for property and income taxes. States vary in their reliance

on different types of taxes. For example, some rely heavily on sales taxes, which are not

deductible under the regular or AMT, while others rely heavily on income or property

taxes, which are deductible under the regular tax but not AMT.

In recent research at Treasury, an analysis was done to determine the effect that the

payment of state and local income and property taxes had on the payment of AMT.

States were ranked on the basis of the average state and local tax deductions (analyzed

as a percentage of income) that were taken by taxpayers who itemized deductions and

who would continue to itemize if state and local tax deductions were eliminated. The

states were then grouped into three categories so that the number of taxpayers who

reside in the states in each category would account for approximately one-third of the

total number of taxpayers.

The research at Treasury indicated that, holding other factors constant, AMT taxpayers

are more likely to live in states that rely more heavily on taxes that are deductible in

determining tax liability under the regular income tax. In the Treasury research it was

estimated that, in 2000, 58 percent of taxpayers affected by AMT lived in high tax

deduction states, 24 percent lived in middle tax deduction states and 18 percent lived in

low tax deduction states. The estimates showed that by 2010, 45 percent of taxpayers

affected by AMT would live in the high tax deduction states, 32 percent would live in

middle tax deduction states, and 22 percent would live in low tax deduction states.28 The

breakout of states according to the working paper’s categorization is shown in figure 5.

 28 The decline was attributed to the increasing affect of another AMT provision, i.e., personal exemptions as discussed in the section

on the redistribution of the tax burden.
16

Figure 5: States categorized by Deductibility of Their Taxes Under Federal Income Tax

Law

Source: Department of the Treasury, Office of Tax Analysis Working Paper 87 (June 2000)

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