Limiting the Damage from the 2008 AMT Train Wreck
By Len Burman :: January 2nd, 2008
As most TaxVox readers know, the political establishment waited until the last possible moment to pass the inevitable extension of the AMT "patch," sparing 20 million taxpayers from the dreaded alternative tax. Now the IRS says that lawmakers' procrastination will delay the start of the tax filing season by about a month—until mid-February—for taxpayers who claim certain tax credits that the AMT would have affected but for the twelfth-hour reprieve.
News reports have blamed the delay on the patch (the temporary increase in the amount of income exempt from AMT), but the real culprit is a little known, pointlessly complicated, and easily fixable provision of the tax law. Under the AMT rules, taxpayers whose regular income tax after subtracting nonrefundable personal tax credits would otherwise fall below tax owed under the AMT rules (called "tentative alternative minimum tax") have to reduce their credits enough so that they do not technically owe AMT. In other words, if your child care tax credit or education credits (to take two examples) would put your regular income tax below your tentative AMT, you have to scale back or even eliminate the tax credits. This provision was actually put into the tax law by the Tax Reform Act of 1986 as a way to make taxpayers aware of how the AMT affects their tax credits.
But this calculation, which has to be done for every personal nonrefundable tax credit, is so complicated that Congress has repeatedly passed temporary legislation so that it would not beleaguer taxpayers. In fact, no one has had their personal tax credits reduced since 1998, and the patch legislation allowed taxpayers to use their personal credits through tax year 2007.
Nonetheless, just the specter of the complicated credit provisions hamstrings the IRS. As long as the tax law limits credits (as it does again starting in 2008), the tax authorities need to be ready to issue forms, worksheets, and instructions to implement the complicated credit take-back, and their computer programs must check that taxpayers who would be affected by the AMT calculate their taxes the right way. When Congress eventually said "never mind" again late last year, the IRS had to reverse course and taxpayers who would like to claim those tax credits will have to wait.
There are two solutions to this problem. One would be to repeal the provision limiting personal credits, at least through 2010 (when the whole income tax code turns into a pumpkin because the Bush tax cuts expire). That would reduce revenues by $11.5 billion through 2010—an amount that could easily be offset by closing loopholes.
That said, loophole closing seems to be a deal-breaker under the current regime. Fortunately, another option exists that would not affect tax revenues, but would greatly simplify matters for the IRS next fall—just define AMT as the difference between tentative AMT net of credits allowed under the AMT and regular income tax net of nonrefundable tax credits.
If the policy gridlock continues through 2008, we might not know which credits are allowed against the AMT until November or December, but this calculation is much simpler for both taxpayers and the IRS to manage. The schedules and instructions that determine tax credit amounts would not depend on AMT rules. The only thing that would matter is which of the credits can be subtracted from AMT liability—a trivial calculation.
The bottom line for taxpayers (and the IRS) would be exactly the same, but the path leading to it would be much, much simpler. And taxpayers might actually be able to file their tax returns and get their refunds next January no matter how badly the policy process fails.
If there ever was a no-brainer tax change, this is it.