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Alternative Minimum Tax effects spreading
Filers must pay extra to the IRS
Friday, April 15, 2005
By Bill Walsh
Washington bureau

WASHINGTON -- Every April 15, Americans are reminded just how much they dislike paying taxes on their income. Philip Priddy is still paying off a $220,000 tax bill on money he never made.

Priddy, a Baton Rouge sales manager for Nortel, was forced to liquidate his savings, sell his boat and his wages are still being garnisheed by the Internal Revenue Service to pay off his debt. Although an extreme example, he is among a fast-growing segment of Americans who are feeling the pinch of the Alternative Minimum Tax, or AMT.

The tax originated in the late 1960s to target super-rich people who employed clever accountants to shield their income from the long arm of the IRS. But because it hasn't kept pace with wage inflation, the U.S. Treasury estimates that 3.8 million Americans this year will have to pay an AMT on top of their regular income taxes.

Most are upper-middle-class people making a comfortable living, but that will soon change, according to the Congressional Budget Office. By 2010, the agency said, nearly 30 million Americans -- 20 percent of all taxpayers and 40 percent of married couples -- will have to pay the extra tax. By then, it will hit two-thirds of taxpayers with adjusted gross income between $50,000 and $100,000, the agency projected.

"It is growing every year and taking in people who were never intended to be hit by the AMT," said Rep. Jim McCrery, R-Shreveport, who has filed a bill to repeal the AMT. "It is already too pervasive in our tax system."

Most taxpayers probably skip right over the line on their 1040 Forms referring to the alternative minimum tax. They are supposed to be calculating it and comparing it to what they owe under the regular income tax, paying whichever is higher. Those most likely to owe an AMT are people with lots of children -- or "deductions" in tax parlance -- and those living in high-tax states.

High-tax New York state had the most residents paying an AMT in 2003. That year, 13,007 Louisianians paid an AMT averaging $3,331, ranking the state 40th overall.

For much of its life, the AMT has fallen on the wealthiest taxpayers, as it was intended. Congress passed a minimum tax law in 1969 after the Treasury secretary shocked lawmakers by testifying at a hearing that 155 people with incomes of more than $200,000, or $1.1 million in today's dollars, had paid no tax at all two years earlier.

Until 2000, less than 1 percent of taxpayers got hit with the extra tax in any given year. Ironically, it was the Bush administration's tax cut in 2001 that plunged more people than ever into the AMT. As more people saw their regular income tax obligations drop, they became exposed to the AMT, which doesn't allow most of the deductions to which Americans are accustomed.

"It's disappointing when you think you will have a big tax break and then you are hit with the AMT," said Martin Nissenbaum, director of personal tax planning at Ernst & Young. "A lot of people don't understand it and then they get a bill from the IRS."

The bill that Priddy, the Baton Rouge man, got almost wiped his family out financially. Like many in the technology sector, Priddy was offered company stock options in lieu of a salary increase. It seemed like a no-lose proposition.

In 2000, he was allowed to buy 8,000 shares of Nortel stock at $10 even though it was trading for $82 at the time. But soon the stock began to plummet, finally hitting $9 a share when he sold.

Unlike a capital gains tax, which places a levy on what an investor earns, the AMT has to be prepaid before any money is earned. Priddy didn't make a dime on his stock options, but in 2001 his AMT was $220,000.

"We didn't have the money," Priddy said. "The IRS basically took my IRA, any clear asset we owned. I sold my bass boat for the money. We kept our house because we had mortgaged that. They took our children's college fund. We still pay the government $1,000 per month. To this day, we still have a lien against our house."

Priddy said the AMT turned his family's comfortable upper-middle-class lifestyle into a daily financial balancing act. "We're right on the border," he said. "If anything big happens, we go under." People exercising stock options have been the hardest hit by the AMT, but they are also the minority. For most people, their AMT averages $4,000.

Still, eye-popping cases such as Priddy's have generated momentum for repealing the AMT on Capitol Hill. The Bush administration has made it a priority, and the president's tax reform commission this week said the AMT violates three principles of good tax policy: It's not simple, efficient or fair.

Former Sen. John Breaux, D-La., vice chairman of the tax reform panel, said the AMT repeal could very likely be among the recommendations in July.

But because the AMT brings a lot of money into the Treasury -- $600 billion to $1.3 trillion in the next 10 years -- getting rid of it is difficult.

Some, such as Rep. William Jefferson, D-New Orleans, say the high cost argues in favor of a quick fix. He suggested indexing the AMT to inflation and returning the tax to its original intent.

"There is some legitimacy to the notion that if you make a higher amount, you should pay some tax," Jefferson said. But McCrery, Jefferson's colleague on the tax-writing Ways and Means Committee, said Congress has sewn up many of the loopholes for high earners that led to the AMT's creation a generation ago.

"It's outlived its usefulness," he said. When asked how he would pay for his proposed repeal, McCrery said, "It's getting more expensive all the time." One group, the Coalition for Tax Fairness, has proposed targeting what it says is the worst aspect of the AMT: its treatment of taxpayers, such as Priddy, who exercise stock options.

Tim Carlson, a lawyer and president of the group, said the fix he envisions would not eliminate the tax but just make sure people who lose money by exercising stock options don't get clobbered by the AMT.

"This would be a solid first step," he said. "When the tax code is taking people's homes and their retirement and garnisheeing their wages for decades to pay taxes on money they've never got, that is something we in America should not tolerate."

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Bill Walsh can be reached at bill.walsh@newhouse.com or (202) 383-7817.