An arcane levy extends its reach

Nation's Business, Nov, 1997 by Joan Pryde

Unlike most small-business owners, Debbi-Jo Horton is intimately familiar with the alternative minimum tax, a complex levy designed to ensure that the wealthiest individuals and profitable companies do not escape taxes altogether. As a certified public accountant, Horton has to tell her clients whether they must pay the AMT And they'd rather not hear about the details.

"Most people don't understand it," says Horton, owner of D.J. Horton & Associates, a two-person accounting firm in East Providence, R.I. "It's such a complicated calculation that to try to even explain it takes hours. Most people say, `You lost me after five minutes.'"

Most small-business owners haven't had to worry about the AMT, but more and more of them will find that they must.

Congress created the AMT in its current form in 1986, setting aside an earlier minimum-tax law that was regarded as much weaker and was not preventing some high-income taxpayers from reducing their tax liability to zero. The current AMT is designed to keep very wealthy individuals and corporations from using exotic tax shelters and hefty deductions to avoid paying a fair share of income tax.

But because Congress has not adjusted key AMT provisions for inflation, each year more individuals who do not consider themselves wealthy are finding they must calculate -- and often pay -- the AMT. The number of taxpayers subject to the AMT will jump from 600,000 this year to more than 6 million by 2006, according to Kenneth J. Kies, chief of staff of Congress' Joint Committee on Taxation.

Says Mark Watson, a director in the Dallas financial-planning office of the international accounting and consulting firm KPMG Peat Marwick: "You'll see more and more people having to pay the AMT" even though their basic tax situation doesn't change.

To ease record-keeping burdens on small corporations, Congress added a provision to the tax law enacted Aug. 5 that exempts businesses with less than $5 million in annual revenues from the corporate AMT. But no such break was added for individuals, including sole proprietors and partners, who report their business income on their personal income-tax forms.

How The AMT Works

Here's how the AMT applies to individuals, including sole proprietors and partners:

If normally you sharply reduce your taxable income by using a number of tax breaks, such as passive losses on an investment or interest on certain types of tax-exempt bonds, you figure your taxable income two ways. First, you calculate your regular taxable income on Form 1040, using all available deductions. Then, to calculate your income for AMT purposes, you add back many of those deductions. You then compute the tax on your AMT income and compare that with the tax on your regular taxable income, and you pay the higher of the two taxes.

The AMT tax rates are 26 percent for incomes up to $175,000 after an exemption and 28 percent for incomes above that figure. The amount exempt from the AMT is $33,000 for an individual taxpayer, including sole proprietors and partners; for a married couple filing jointly, it is $45,000.

The five regular income-tax rates for individuals range from 15 percent to 39.6 percent.

The AMT's exemption levels were designed to shield most taxpayers from having to pay the AMT or even go through the rigors of calculating whether they are subject to it. But the AMT exemption on thresholds have remained unchanged since 1986, while ordinary tax deductions and the personal exemption have risen because of inflation. As a result, taxpayers in middle-income groups will increasingly find their AMT tax getting closer to their regular tax and ultimately exceeding it.

The fact that many people of relatively modest income will become subject to the AMT is troubling, says Kies.

The Center on Budget and Policy Priorities in Washington, D.C., estimates that at least some of those taxpayers are going to be in the 15 percent tax bracket, which in today's dollars could include a family of four with an annual gross income of nearly $60,000, or a single-parent family making close to $50,000 a year.

The 6 million that Kies says could be covered by 2006 would still represent a small percentage of the total number of individual income-tax returns filed, which for the 1996 tax year topped 100 million.

Nonetheless, tax experts say, the number will be large enough to net many unsuspecting taxpayers who have never heard of the AMT. It also will mean that many more individual taxpayers -- including sole proprietors and partners -- will at least have to do the AMT calculations even if it turns out that they don't have to pay the tax.

Nullifying The Deductions

How does a typical taxpayer with no unusual tax breaks deal with the AMT? Although the deductions for mortgage interest and charitable contributions are permitted in calculating AMT income, almost no other ordinary deductions can be applied.

The tax code lumps those deductions together with more-exotic tax breaks and calls them all AMT preference items." Any such items that a taxpayer has used to calculate ordinary taxable income must be added back to calculate AMT income. In addition, AMT income cannot be reduced by the $2,550 personal exemption that each taxpayer and dependent is permitted on a regular return.