Is the AMT D.O.A.?  

Is this coming at you too fast? First all the new rules, Code and Circular 230, that cause preparers to rethink internal controls, to consider whether certain clients’ tax position proclivities can no longer be accommodated, and to finesse higher billings to clients who may not realize the tax positions they have taken in the past. Now Congressman Rangel, Chairman of the House Ways & Means Committee, has unveiled the outlines of major tax reform that will significantly impact tax advisors. In general, commentators believe that this will not be enacted this year and, if enacted in 2008, will be vetoed, so even though the current effective date of January 1, 2008 is highly improbable, it is a warning shot across the bow that signals the general scope of what one may realistically, given today’s current political calculus, expect as of January 1, 2009. One should be cautioned that these proposals may be fine-tuned in the future to eliminate some of the rough edges that are noted in the following paragraphs.

The centerpiece of the proposed legislation is the repeal of the individual alternative minimum tax. While this may sound like good news for many taxpayers, the projected one trillion dollar cost of repeal is to be offset by revenue raisers, and the obvious source of such revenue is the class of “high-income” taxpayers, because, to paraphrase Willie Sutton’s legendary quote, that’s where the money is. That revenue will be raised by including a surtax on the incomes of single taxpayers over $150,000 and on the incomes of married couples over $200,000. This surtax will range from 4 percent to 4.6 percent, depending on the income level of the taxpayer. Coincidentally – or is it? – this will have the effect of resurrecting the old 39.6 percent tax-rate bracket that applied in 2000 without a repeal of the legislation that reduced the highest individual tax brackets to 35 percent. It would amount to the largest individual income-tax increase in American history. Many taxpayers now hit hard by the AMT may find no relief at all, because the increase in the effective tax rate for regular tax purposes may more than offset the elimination of the AMT. This will certainly be the case for taxpayers with incomes above $500,000 since they were largely unaffected by the AMT.

Low-income taxpayers, including those who currently pay no income taxes, would benefit from an increased standard deduction and enhanced refundable earned income tax and child credits, although no dollar levels have yet been announced.

Corporations will benefit from a reduction in the corporate tax rates from a highest (without regard to certain phase outs of lower tax rates) tax rate of 35 percent to 30.5 percent. At least at the high end this can reduce corporate taxes by approximately 13 percent. What goes is the manufacturers’ deduction that provided a tax-rate reduction of all businesses that engaged in domestic production, scheduled to be approximately 9 percent in 2008. This would reduce the highest tax rate to an effective 31.85 percent tax rate. Because the reform would slough off the deduction, individuals who operated their businesses as a sole proprietor, partnership/LLC, or S corporation will, in addition to the surtax, experience tax increases from the loss of the deduction, while certain C corporations that do not have domestic production, such as service industries, will apparently enjoy a tax reduction. Since the tax-rate reduction is not across the board on all tax brackets, corporations in the lower brackets will experience no tax reduction, and, in the case of those who had taken advantage of the manufacturers’ deduction, a tax increase. C corporations that have used LIFO may also find themselves with a tax increase if and when the proposal to repeal its use is enacted, even if its impact is stretched out over eight taxable years.

Although these proposals are unlikely to be enacted immediately, prudence dictates that the CPA should begin considering their impact now. Should a new business be organized as a C corporation rather than a pass-through entity? Should a taxpayer accelerate income to 2008? Defer deductions to 2009? This just scratches the surface.

Of more immediate attention is the extension of provisions expiring in 2007 or 2008, which is likely to be enacted in November. There is substantial support for another AMT patch, an increase in the AMT exemption (to $64,950 in 2007 for married filing jointly), in order to avoid the political fallout Congress believes would follow from a projected increase from 4 million taxpayers to 25 million taxpayers subject to the AMT should the current ($45,000 for married taxpayers) exemption level remain in place. It is likely, but not certain that the AMT patch will piggy-back onto the extender’s legislation.

Advising clients about a host of tax issues, such as estimated tax payments for future years, is implicated by the future of the AMT, patch or repeal. In this era of tax flux, practitioners will, to borrow a phrase, more likely than not have to wear their pencils down to the nub to provide complete and comprehensive tax advice.

These and other issues are examined in the following Surgent McCoy courses: