A Tax That Liberals and Conservatives Hate

A little-known tax created to stop the wealthy from using exemptions to ease their tax burden could wind up hurting millions of middle-income Americans in the next decade.

If the system isn’t changed, experts say, the alternative minimum tax will likely severely limit the benefits many middle- and upper-middle class citizens would have reaped from President Bush’s proposed $1.6 trillion tax cut over 10 years.

"A lot of people will find out that they didn’t get much of a tax cut from Bush, and even worse, that their tax filing got a whole lot more complicated," said Robert McIntyre, director of Citizens for Tax Justice, a liberal research organization in Washington. "They need to fix the alternative minimum tax -- there’s no doubt about it. The problem is, no one is willing to pay for it."

The estimated cost of remedying the situation has been estimated at anywhere from $100 to $300 billion over the next 10 years.

Without changes to the current system, a family of four in the year 2008 with an adjusted gross annual income of $150,000 would end up paying about $3,000 more to the IRS than they otherwise would. Though Bush's tax cut plan would call for them to pay $24,186 as opposed to the $28,321 they'd pay under current rates, factoring in the AMT spikes the bill to $27,248, wiping out most of the Bush tax cut.

Tax Reform Needed, Some Say

Kenneth Kies, a co-managing partner of the Washington tax practice at the accounting firm Price Waterhouse Coopers, said the situation highlights the need for comprehensive improvements in the tax system.

"There are certain things that are in need of reform," Kies said. "The most obvious problem the current income tax code has is the AMT. There’s a strong bipartisan consensus that this is the one thing that really needs attention."

The AMT was implemented in 1969 as a parallel income-tax system, after it was discovered that about 155 upper-class taxpayers had legally gotten out of paying any significant amount to the Internal Revenue Service in 1966 by relying on deductions, credits and other loopholes.

"The AMT was enacted because of a few horror stories," said Bill Ahern, a spokesman for the Tax Foundation, a research group in Washington that favors tax and social security reform. "There was a public outcry…that high-income individuals could avoid taxes without tax evasion."

Single people with incomes below $33,750 a year and married couples filing jointly with incomes below $45,000 are generally exempt from the alternative tax. But above those earnings, depending on the credits and deductions a taxpayer claims on his regular tax returns, the AMT could apply.

In other words, many taxpayers will wind up having to fill out two returns -- one for regular income taxes and one for the alternative tax. If the alternative tax figure turns out to be larger than the regular one, taxpayers must hand over that amount to the federal government. Unlike the regular tax, fewer credits and deductions can be claimed with the AMT.

Because the alternative tax was only expected to affect about 1.5 million Americans this year and the heaviest impact won’t come until later, the White House and Congress are putting off a permanent solution.

"Something …eventually has to be fixed and we will work with Congress to deal with it in due course," said Mark Weinberger, assistant treasury secretary for tax policy.

Weinberger said the Bush administration is concentrating first on getting its tax cuts passed through Congress.

Bureaucratic Shortsightedness

According to Ahern, the elimination of inflation adjustment when tax rates were raised by the Clinton administration 1993 has created the current situation of the tax hitting middle income earners as well as the wealthy.

"It started creeping down the income spectrum from the high-income people to the medium-high people," he said.

Ahern also says an opportunity was missed to do away with the tax in 1986, the last time Congress enacted significant tax reform. 

And if nothing is done, more and more Americans will find themselves in the position of having to pay the alternative tax as inflation raises their income.

Some, such as Kies, believe the alternative tax should be repealed entirely. But others, such as McIntyre, think it needs to be modified to serve its original purpose by raising the income and exemption levels and adjusting it for inflation. That way, he said, most people won’t be affected.

But if the problem is left alone indefinitely, about 36 million Americans could be paying the alternative tax by 2011. Some members of the middle class and upper-middle class "will get zapped," McIntyre said.

-- The Associated Press contributed to this report