Shadow tax hits Massachusetts residents

For those of you in Massachusetts unfamiliar with the trappings of the Alternative Minimum Tax, or AMT, you better educate yourself. The number of taxpayers subject to the AMT is growing faster than the federal budget deficit. The Congressional Budget Office estimates that over 30 million taxpayers will be subject to the AMT in 2010. Furthermore, Massachusetts residents are much more likely than residents in other states to have to pay the AMT.

In 1969, the US Treasury became aware of approximately 155 high wealth families whose tax avoidance strategies were so effective that they were paying little or no federal income taxes. Their strategies were completely legal and in compliance with the then existing federal tax code. To target these families, Congress passed the AMT, and President Nixon signed it into law. The AMT is basically a parallel tax code with its own set of tax rates, deductions, exemptions and credits. You as a taxpayer are required to calculate your federal income taxes under the “regular” rules as well as under the AMT rules. The IRS requests that you pay the greater of the two.

Massachusetts residents are disproportionately impacted by the AMT. In 2005, Massachusetts residents were 57 percent more likely to be hit with the AMT than the national average. The average liability in 2005 for a Massachusetts resident was $4,049. The reason for this disproportionate impact is that the AMT does not allow for state income taxes or real estate taxes to be deducted from taxable income. Massachusetts residents typically get a big deduction for our state income taxes and relatively high property taxes. As such, we are much more likely to be hit with an AMT liability than people in areas where local taxes, property values and incomes are lower.

Further distressing news to Massachusetts taxpayers is that the AMT fails to accomplish what it set out to do, which was levy additional taxes on wealthy families. In fact, the largest burden is falling on the middle class and upper middle class taxpayer. The Congressional Budget Office estimates that in 2010 two thirds of taxpayers with an adjusted gross income of between $50,000 and $100,000 will pay the AMT. A full 95 percent of married couples with an adjusted gross income of between $100,000 and $200,000 will pay the AMT. As taxpayers’ incomes increase above $200,000, the percent subject to AMT declines to the point where less than 30 percent of taxpayers with an adjusted gross income of in excess of $500,000 will pay the AMT.

Although there is a significant call to repeal the AMT, it is not likely to happen anytime soon. The US Treasury needs the estimated $1.2 trillion in tax revenue that it is going to raise in the next decade. In 1999 the US House and Senate passed legislation that would have repealed the AMT as of December 31, 2007. This bill was passed largely on party lines. Even though the AMT disproportionately impacts its residents, the entire Massachusetts delegation in Washington D.C. voted against this bill. Regardless, the bill was vetoed by President Clinton and never became law. So the AMT is with us for the foreseeable future and its tentacles will be grabbing more of us over the coming years. Any tax planning strategy should consider its impact.