AMT Patch Approved

A few weeks ago, I posted a story about the Alternative Minimum Tax (AMT) and how it would hit an estimated 1-in-5 taxpayers in 2010 if Congress didn't take action.  Luckily, Congress did take action.  The bill sets the following exemption amounts:

• Married: $72,450 in 2010 and $74,450 in 2011
• Single and head of household: $47,450 in 2010 and $48,450 in 2011.

The AMT was first enacted in 1969 in an effort to force a small number of wealthy taxpayers (155 to be exact) who were reporting little or no taxable income.  Like most aspects of the tax code, the AMT is complex and is hard to explain in a blog post without making your eyes glaze over.  Essentially, the AMT is an "alternate" calculation of taxable income in which certain deductions are not allowed and certain items are calculated differently than for "regular" tax calculations.

Taxpayers are allowed a certain amount as an AMT exemption (see the amounts above) but ridiculously, the exemption amount is not indexed for inflation.  Instead, Congress passes "patches" to the AMT exemption amount year after year that increase the exemption for a year or two at a time.  Unfortunately, even with higher exemption amounts, millions of people (4.5 million in 2009) have been hit with AMT.  Without the patches, that number would be even higher.  Again, when the law was enacted 40 years ago, it was targeted at 155 high-income people, but now it's grown into a monster.

Why isn't the AMT exemption set higher to begin with and indexed for inflation (the "non-patched" base AMT amounts are the same as they were in 1993)?  It's a way to boost revenue projections when lawmakers calculate the "cost" of legislation.  For example, the current AMT "patch" is set to expire at the end of 2011.  So long-term budget projections will forecast revenue for 2012 and beyond based on the old, lower AMT exemption amounts, even though we all know that Congress will pass another "patch" for those later years.

Analyzing the Tax Cut Deal

President Obama signed a tax bill into law yesterday (Friday) that gives us some clarity on what the tax situation will be for 2011 and 2012.  Here are the highlights of the bill:

• Tax brackets to remain the same, with a 10% bottom rate and a 35% top rate.  Without this legislation, the bottom rate would have increased to 15% and the top rate to 39.6%.
• A "payroll tax holiday" that reduces the amount of FICA withholding by 2% (self-employed taxpayers will see their self-employment tax decrease by 2%).  For a person making $40,000/year, this would equal an $800 savings.  (But the Making Work Pay Credit is expiring, which negates some of the savings.)
• Another "patch" to the Alternative Minimum Tax that will help millions of taxpayers avoid this tax.
• The capital gains and qualified dividends rates remain at 0% for taxpayers in the 10% and 15% tax brackets, and at 15% for taxpayers in the higher tax brackets. 
• The Child Tax Credit will remain at $1,000 (it had been set to decrease to $500 in 2011).
• You can claim dependent care expenses of $3,000 for one child or $6,000 for two or more children.  These amounts had been set to decrease to $2,400 and $4,800.
• The expanded Earned Income Credit remains in place through 2012.
• The credit available for energy efficient upgrades to your home remains in place through 2012 (it had been set to expire at the end of this year).
• Extension of the American Opportunity Credit for college expenses, and an extension of the "above-the-line" deduction for college expenses.
• Special 100% "bonus depreciation" for purchases of brand-new assets from September 9, 2010, through the end of 2011.
• The estate tax returns with a $5 million exemption per person, and a 35% top rate, retroactive to January 1, 2010.  Estates arising in 2010 will have the option of of using these rules, or using the "old rules" of no estate tax and a reduction in the amount of increase in carryover basis.

Deal Reached on Taxes (Maybe)

President Obama and Republicans in Congress have reached an agreement on taxes.  The agreement calls for the following:

• Extension of the Bush Tax Cuts through the end of 2012.  For more on what this means, see this article posted a few days ago on the Dinesen Tax Times.
• A two-year "AMT patch."  This will prevent an estimated 22 million taxpayers from falling victim to this tax.  For more on what would happen without this patch, see this Dinesen Tax Times article.
• Extension of the expanded Earned Income Tax Credit, extension of the expanded child tax credit, and extension of the American Opportunity Credit for college expenses.
• Extension of miscellaneous tax provisions such as the additional standard deduction for real estate taxes paid by non-itemizers.  The $250 "above-the-line" deduction for classroom expenses of K-12 teachers is also extended.
• Unlimited expensing of new assets in 2011.
• A reduction in the employee portion of FICA withholding, from the current 6.2% to 4.2%.  For a person making 40,000 per year, this would equate to a savings of $800 over one year.  This provision may have been put in the agreement to make up for the expiration of the Making Work Pay Credit.
• The estate tax will return with a $5 million exemption and a top rate of 35%

Democrats are not happy with this proposal, so it remains to be seen if it will actually be passed into law.

AMT Could Hit 20% of Taxpayers in 2010

(UPDATE 12/22/10:  The tax bill signed into law on December 17, 2010, does provide an AMT patch that will help millions of Americans avoid the AMT.  Read the story here.)

We are hearing constantly about Congress debating the "Bush Tax Cuts" and whether to extend the tax cuts for only people who earn less than $250,000 a year, or to extend them for all taxpayers.  But there are other tax provisions unrelated to the Bush Tax Cuts that Congress needs to take action on this month -- and in my opinion, the most important of those provisions is the alternative minimum tax (AMT).

If Congress does nothing regarding the AMT, millions upon millions of taxpayers (an estimated 1-in-5) will be hit with this tax, which, when it was enacted in 1969, was only supposed to hit a few extremely wealthy people.  The AMT exemption amount for a married couple will drop from $70,000 in 2009 to just $45,000 in 2010; and from $46,700 in 2009 for single or head of household to $33,750 in 2010. 

The AMT is too complex to go into in one article, but suffice to say that at the very least, Congress MUST extend the 2009 exemption amounts into 2010 or lots of people will be very unhappy when they find out they owe this tax….