The Individual Alternative Minimum Tax: Interaction with Marriage Penalty Relief and Other Tax Cuts
Released: 2001-06-12T00:00:00

An Overview of the AMT

The AMT provides for an alternative tax calculation on a broader tax base than theregular tax. Individuals add back a variety of provisions including not only business provisions but certain itemized deductions (mainly state and local taxes, some medicalexpenses and miscellaneous deductions), the standard deduction, and personal exemptions. After an exemption of $45,000 for joint returns and $33,750 for single returns, the first$175,000 is taxed at 26% and the remainder is taxed at 28%. Exemptions are phased out. Theindividual compares AMT liability and regular tax liability and pays the higher one. Whilethe AMT base is broader than the regular tax base, there are many provisions that are notincluded in its base, notably the benefits of lower capital gains tax rates and the exclusion fortax exempt bonds, and the itemized deduction for home mortgage interest. Indeed, theelimination of the capital gains exclusion in 1986 caused a significant contraction in thenumber of taxpayers subject to the AMT; the current rate preferences are not part of the AMT. Credits are automatically included in the base (i.e., effectively disallowed), although underprovisions adopted as part of H.R. 1836 , this rule does not apply to the mostimportant credit, the child credit. (1)

However, unlike the rest of the income tax, the AMT exemptions are not indexed to inflation. The result has been an increase in the number of taxpayers who are covered by theAMT. (2)

In 1987, about 140,000 returns paid the AMT, constituting 1/10 of one percent of allreturns filed. This number was below the 4/10 of a percent of returns that paid the tax in 1984and fell largely because the deduction for capital gains was eliminated by the 1986 tax act andtherefore automatically affected coverage under the AMT. Inflation, however, took its toll. By 1999, the AMT covered 823,000 returns, constituting 6/10 of a percent of all returns filed,an increase in percentage share of 600% between 1987 and 1999. This effect occurred eventhough the exemptions were increased in 1990.

More growth is ahead, however. In 2009, the Joint Tax Committee projects that over 9 million taxpayers will pay the AMT, constituting 6.3% of all tax returns filed, an increase inpercentage share of over a thousand percent from 1990 to 2009. The AMT would probablyconstitute a larger share of joint returns filed, since incomes are higher for these returns thanfor single returns. The AMT would also constitute a larger portion of returns with tax liability;since typically about a quarter of returns filed pay no tax, taxpayers on the AMT wouldconstitute over 8% of returns with tax payments. Another 6 million returns would have been subject to limits on tax credits, such as the child credit and education credits enacted in 1997;this surge in the AMT coverage would have occurred in large part in 2002, but H.R. 1836 made the most important credit (the child credit) permanently availaleunder the AMT.

While the AMT will still be concentrated among higher income individuals, it will gradually reach further down into the income distribution. This shift in the distribution isshown in Table 1. Note that this table understates the coverage of the AMT and its reach intothe middle income classes, because it does not include those taxpayers whose credits are stilllimited by the AMT (such as education tax credits). But it does illustrate how the failure toindex exemptions will substantially expand the AMT.

As this table illustrates, the shift of exposure to the AMT from the very highest income classes to the middle and upper middle income classes is dramatic over time even withoutthe tax cuts in H.R. 1836 . In 1998, almost half of AMT taxpayers fell into the1.6% of tax-filers with adjusted income over $200,000; and over three-quarters fell into thetop 8% of taxpayers who had income over $100,000. In 2008, less than 15% of AMTtaxpayers have incomes over $200,000 and about half have incomes of $100,000 or more. Moreover, these effects occur despite the fact that taxpayers in these income classes areaccounting for a larger share of total taxpayers as incomes rise over time.

Table 1: Percentage Distribution of AMT Taxpayers by Income Class (Excluding the Effects of Limits on Credits), Prior to H.R.1836

Source: Data from and CRS calculations based on data from Joint Committee on Taxation.

A comparison of the fraction of taxpayers on the AMT in each income bracket shows a similar dramatic shift. While the shares increase in all of the middle and upper brackets, thedramatic changes are in the middle income brackets. For example, the share of taxpayers onthe AMT at income between $75,000 and $100,000, which most people would consider in themiddle class would increase from 1% to 20%.

These effects understate the shift of the influence of the AMT toward the middle classthat is expected in the future because they do not include the interaction with the tax creditsthat were adopted in 1997. Under the AMT provisions, credits are limited to the excess ofregular tax over AMT liability except for the child credit which is now specifically excluded. For 2008, there would have been another 6 million returns that are constrained by the taxcredit; however, most of these will probably no longer be affected because they reflect effectsof the child credit.

The Treasury Department recently completed a study of the AMT that showed a significant growth in the share of AMT taxpayers, inclusive of the effects of the credit. (3) Table2 shows these effects for 2000, 2005. and 2010. Overall, 15.7% of taxpayers will be coveredby the AMT in 2010, and the shares rise to as much as 64%. These numbers will be smallerafter considering the effects of H.R. 1836 , because of the adjustment in thecredit, but larger because of the lower rates and other tax cut provisions.

Table 2: Percentage Distribution of AMT Taxpayers by Income Class (Including the Effects of Limits on Credits), Prior to H.R.1836

a - greater than 75%

b - less than 0.05%

Source: Treasury Department

The cost of correcting the AMT is significant. According to data from the Joint Committee on Taxation, indexing AMT exemptions would cost $13.9 billion by 2008. Thiscost would be larger in the wake of the recent tax changes. Eliminating the credit limitprovision would cost about $1 billion currently, but would cost many billions of dollars by2008 or 2009. Eliminating the credit limit provision and adding standard deductions wouldcost the U.S. Treasury $26 billion by 2009 and $96 billion for the period 1999-2009. (4) According to the Treasury study AMT tax liability was projected projected to rise from $6.4billion in 2001 to $38.2 billion in 2010 before considering H.R. 1836 , with atotal amount of $182 billion over the ten year period. This number will now be higher dueto the rate reductions and marriage penalty provisions in H.R. 1836 .

Clearly, the AMT will become increasingly important in the years to come, in the number of taxpayers covered and revenue cost of altering the AMT. And any tax cut thatreduces regular tax liabilities and does not also alter the AMT will interact with the AMT intwo ways: it will increase the number of taxpayers on the AMT and the number affected bythe credit limit, and it will cause some or all of the tax cut not to be received by certainfamilies.

Tax provisions that are aimed at reducing taxes for joint returns may particularly interact with the AMT because married couples have a greater number of dependents, which increasesthe likelihood that taxpayers will be under the AMT. Married couples also tend to havehigher incomes and, while their AMT exemptions are also higher, may be more likely to beaffected by the AMT. The interaction is also affected by how the tax change is distributedacross the income classes, since only joint returns with more than $45,000 of taxable incomeare potentially subject to the AMT. Treasury data show that 21% of joint returns will beaffected by the AMT in 2010, compared to 15.7% for the overall taxpaying population. Forjoint returns with dependents, the share affected by the AMT rises to 39%. Thus, tax cutsdirected at joint returns are particularly likely to be restricted due to the AMT.

Interaction Between Marriage Penalty Relief and the AMT

A marriage penalty arises for some families because family income is combined andsubject to progressive tax rates. Since the standard deductions and rate brackets, while largerthan those of singles, are not twice as large, marriage can cause the loss of standarddeductions and cause some income to be taxed at higher rates. Other couples, however,experience bonuses; this outcome tends to arise when earnings are relatively unequal or whenthere is only one earner, because the exemption amounts and rate brackets are larger for thejoint returns filed by married couples than for singles' returns.

Provisions of the Recent Marriage Penalty Legislation

H.R. 1836 proposed to address the marriage penalty for most taxpayers, granting bonuses to many taxpayers who formerly had penalties and expanding the bonusesof those with bonuses. (5)

About 60% of joint returns are in the 15% bracket and would have any penalties that did exist eliminated (and bonuses increased) merely through increasing the standard deductionto twice that of single returns. Under H.R. 6 , a stand alone marriage penalty billpassed earlier this year by the House, this provision was estimated to cost $6.3 billion by2009. Another 26% are in the 28% bracket and would have the remainder of any penaltieseliminated (and bonuses increased) through both the standard deduction and the widening ofthe first bracket to twice that of single returns. This provision would have cost $ 26.3 billionby 2009. Thus, 86% of joint returns, ignoring the earned income tax credit and the AMT,would be covered by these provisions. There were also some provisions for partially reducingthe marriage penalty for the earned income tax credit, costing $1.4 billion by 2009. Someindividuals whose income is taxed above the 28% bracket currently would also have had theirpenalties eliminated, and since the next rate bracket is only slightly higher (31%) thisapproach would have also most marriage penalties for the vast majority of married couples(96% are in the 31% bracket or below). (6)

These numbers do not take into account the rate reductions and the effect of thosereductions on the AMT. H. R. 1836, which included the provisions in H.R. 6 ,will have a slower phase-in and also a sunset. Because the estimates are calculated with asignificant rate reduction, the cost will be smaller, reaching about $3.1 billion for the standarddeduction and $4.7 billion for the increase in the 15% bracket. The increase in the bracketwidth would shift income from a 15% bracket to a 28% bracket under current law and to a25% bracket with the proposed rate revisions. Adjusting for this effect would make the costunder the new rate structure 10/13 of the cost under the old and reduce the estimate to $20billion, only accounting for a small part of the difference. About one fourth of the current15% bracket is being shifted to a 10% rate, lowering the cost of the standard deduction ($6.3billion) to at least 0.1375/0.15 under the new system compared to the old. But thisadjustment would shift the cost to $5.7 billion not the $3.1 billion reported. The cost of theearned income credit provisions is actually higher under H.R. 1836 than under H.R. 6 . The only remaining explanation is that large numbers of joint returnswill shift into the AMT because of the new rate schedule and will not become eligible formarriage penalty relief.

A large part of this effect is that more individuals will be pushed into the Alternative Minimum Tax because of the rate reductions and these individuals will not benefit from themarriage penalty relief. As a result, many joint returns will not receive marriage penaltyreduction benefits. Marriage penalties still exist for higher income taxpayers as well. However, the flatter rates themselves would also reduce marriage penalties for thoseindividuals who remain on the regular tax.

The Senate marriage penalty proposal in the 106th Congress initially proposed to expand the 28% bracket, which would increase the coverage of high income taxpayers. An even largerfraction of this group would ultimately fall under the AMT.

Interaction between the AMT and Marriage Penalty Legislation

The amount by which marriage penalties are reduced by the proposed legislation will declined over time because of the AMT. If a taxpayer is on the AMT, marriage penalty reliefprovisions would not have benefitted these taxpayers. Moreover, for taxpayers subject tocredit limits, a change in the regular tax would have been offset by a loss in the credit, so thetaxpayer would not have benefitted from the tax revision. And, the tax cuts in the marriagepenalty legislation were likely to substantially increase the number of taxpayers on the AMT,a number that, as noted earlier, is already growing rapidly.

In 2000, the Treasury Department has estimated that the marriage penalty alone (from the stand alone provisions) would have increased the number of taxpayers on the AMT orconstrained by it via credits by 49% by 2010, raising the total number from 17 million to 25million. (Of the 17 million taxpayers already affected, 12.6 million are on the AMT and theremainder constrained by the credit). Since there were 91 million taxable returns in 1996,which would probably not grow much over 1% or 2% per year, 22% to 24% of taxpayerswould then be on the AMT or affected by the credit - a provision that currently affects lessthan one percent of taxpayers. Thus, it is clear that the growth in the AMT coverage wouldhave been sharply increased by this legislation. The revenue collected by the AMT would alsohave increased, by about 48%, from $38.2 billion per year to $46.5 billion. These resultswould have been even larger with the rate cuts.

Treasury estimates indicate that 28% of the marriage penalty tax cuts in the 106th Congress's version of H.R. 6 over the next ten years are taken back by the AMT,making the net budget effect $67 billion smaller. (7) This take-back rate rises rapidly andreaches 44% by 2008. Thus, absent revisions to the AMT, about half the tax cuts in themarriage penalty legislation would have disappeared after ten years. Eight years after thelegislation is enacted, more than 47% of couples with two children would have been on theAMT.

These effects are mitigated by provisions that allow personal credits to be offset against the AMT but increased by the rate reductions.

Lessons from the Marriage Penalty Example

This analysis of H.R. 6 in the 106th Congress shows how a tax proposal that affects many ordinary income taxpayers has powerful interactions with the AMT. Dependingon the nature of the legislation, the interactions can be larger or smaller. Proposals that lowertax rates or narrow brackets across the board would also be expected to have significantinteractions with the AMT because they tend to affect higher income taxpayers proportionallymore. Taxpayers already on the AMT would get no tax cut, and some taxpayers would beshifted to the AMT. For example, even in the year 2000, 44% of taxpayers with incomesover $50,000 would have received less than the full 10% tax cut in H.R. 3 , anacross-the-board tax cut proposal in the 106th Congress. (8) Tax cuts that add to credits or otherprovisions disallowed by the AMT would also interact with the AMT. Tax cuts that aredirected primarily at lower or middle income individuals would be less affected by AMTinteraction, at least in the near future. Left unchecked over a very long period of time, ofcourse, virtually all taxpayers will eventually fall under the AMT provisions as theexemptions erode in value.

There were offsetting effects in the initial Senate Finance Committee proposal for the marriage penalty ( S. 2346 , S. 2839 ). This proposal also made theability to offset credits, such as the child credit, against the AMT permanent. This changewould have reduced the number of middle and upper middle income taxpayers who would have their credits limited as a result of the marriage penalty or who would be switched to theAMT. The expansion of the 28% rate bracket, however, would have expanded the interactionbetween the marriage penalty legislation and the AMT. For tax year 2000, the top of the 28%rate was $105,950, while twice the top of the single bracket is $124,900. Since adjusted grossincome is higher than taxable income, this change will affect many higher income individuals.

The final proposal adopted by both houses, H.R. 4810 , included the credit offsets and not the 28% bracket expansion, so the effects of the AMT in limiting these tax cutswould have been smaller in this legislation.

Policy Options and Issues

While the previous analysis describes the importance of AMT interaction with proposedtax cuts, there are a variety of approaches that could be taken to dealing with the AMT. However, one important point to note is that cutting taxes without altering the AMT, byincreasing the coverage of the AMT, makes proposals to slow or reverse its growth inimportance more costly in terms of revenue loss.

The 1997 Credit Interaction

The Congress has considered the most urgent issue that of dealing with the lack of offset of the credits adopted in 1997, which immediately catapulted many middle class taxpayersinto an interaction with the AMT that reduced their credits. Legislation temporarily correctingthat problem had already been enacted, and this provision was made permanent in the caseof child credits. Child credit provisions in H.R. 1836 eventually cost about $25billion per year, but this number reflects both a doubling of the credit and the AMT provision.Earlier estimates suggest eliminating the credit limit provision would cost about $1 billioncurrently, but would cost many billions of dollars by 2008 or 2009. Estimates for the Senateversion of the 1999 tax cut bill, H.R. 2488 , indicated a $1 billion cost currentlyfor both eliminating the restriction and allowing some small additional exemption, a cost thatgrew to become $26 billion in the tenth year.

Indexing the Exemptions

According to Joint Committee data, indexing AMT exemptions would cost $13.9 billion by 2008. Indexing the exemptions is the step that would be necessary to begin to keep theAMT more or less fixed in relative importance in the tax system, assuming that no otherchanges in the regular tax structure occurred.

The AMT as the Tax of the Future

Some might see the AMT as a desirable, relatively-flat alternative tax with a wider base, and consider the expansion of the AMT desirable. If that is the case, of course, then the AMTstructure itself might be examined in light of general tax principles. (9) The exemption levelsin the AMT are not adjusted for family size or for head of household status; there are marriagepenalties within the AMT structure, and tax preferences are not uniformly included orexcluded. For example, while the AMT base disallows certain itemized deductions (mainlytaxes) and business preferences, it leaves other important preferences intact (capital gainsdifferentials, home mortgage interest deductions, exclusions for tax exempt interest on generalobligation state and local bonds, and exclusions for employer-paid fringe benefits). And, ifthere is concern about the marriage penalty in the regular tax, there is also an issue about themarriage penalty in the AMT.

Phasing Out the AMT

Others might see the AMT as an unnecessary and complicating feature of the current tax system. Under this view, adjustments to limit tax preferences should be directed at thepreferences themselves and not some overall restrictions on their use as embodied in the AMTapproach. These individuals might like to see not only corrections to allow the 1997 creditsto be used against the AMT and indexation of the AMT exemption levels, but also steps toeventually eliminate the AMT. Some steps in this direction were already taken for thecorporate AMT in 1997, where depreciation rules were brought more in line with regulardepreciation.

Revising the AMT and Coordinating with Other Tax Revisions

Others want to see the AMT continue as a general back-up mechanism to keep tax preferences from being overused, but limited to a small fraction of the population. For them,several issues arise. While the indexation for price inflation of the exemption levels is clearlyappropriate to maintain the relative importance of the AMT, other questions are not as easilyanswered. They include questions as to whether the current base of the AMT is appropriateto its purpose, and how to adjust the AMT in tandem with regular tax changes to ensure thatit fulfills its role.

The preferences taken away by the AMT are selective. They include, for example, itemized deductions for state and local taxes, but not for mortgage interest, even though a casemight be made that the former is not a preference, while almost everyone agrees that the latteris a preference. They do not include the major investment subsidies (capital gainspreferences and tax exempt bond interest), although they include a variety of business relatedpreferences. They include personal exemptions and standard deductions, although therationale for this inclusion is that the AMT flat exemption is much larger than the sum of thestandard deductions and personal exemptions.

How the AMT should be altered as regular tax changes are made is also unclear. For example, if the principal purpose of the AMT is to limit the use of preferences, there is noapparent reason why changes in the basic structure of the tax system (wider brackets, lowerrates, larger standard deductions) should trigger additional coverage under the AMT. It wouldbe appropriate to simultaneously adjust the AMT deductions, brackets and rates to conformto the rate changes. In that case, if the standard deduction increases by $500, the AMTexemption should increase by that same amount.

However, the adjustments in the AMT are limited and imperfect. For example, there is no adjustment for family size and no adjustment for head of household status. There are onlytwo rate brackets and the width of the first bracket does not bear a close relationship to thewidth of the regular income brackets. The exemption is phased out at high income levels. Thus, in the marriage penalty proposal, while it might make sense to increase the AMTexemption by the increase in the standard deduction, it is not clear what, if any, conformingchange the expansion of the 15% rate bracket should induce. Thus, it is not clear that changesof these nature should trigger conforming changes in the AMT.

Also, under this view of the AMT there appears no clear reason to allow credits under the AMT although there is a reason to adjust the AMT for the expansion of the standarddeduction in the marriage penalty legislation. A case might be made for an adjustment in thechild credits, on the grounds that these credits are the equivalent of increasing personalexemptions and that such credits should be allowed against the AMT. There is less of ajustification for other types of credits, and the case for the child credits is complex becauseonly some taxpayers receive those credits, but the AMT exemption is uniform (distinguishingonly between single and joint returns).

Conclusion

The growth in the AMT has been considered a potential problem for some time, and itsimportance increases with tax cuts, such as those passed in 1997 and 2001. Because of the AMT, not all taxpayers receive the full amount, or even any, tax cut. Moreover, every reduction in the regular tax that is not accompanied by adjustments in theAMT increases the number of taxpayers who pay the AMT and the complications for thosetaxpayers in filing their tax return. The marriage penalty legislation, as well as the ratereductions, cause a significant expansion of the fraction of the fraction of families. And eachtime this issue is not addressed, the higher the cost grows for doing so at some future time.