New tax act keeps AMT from mushrooming-for one more year.

The Working Families Tax Act of 2004 does not solve the growing problem of the alternative minimum tax system, but it at least postpones the problem for some taxpayers for another year.
The alternative minimum tax (AMT), a parallel tax system that is snaring more and more middle class taxpayers, will keep the same elevated exemption limits for tax year 2005 that are in place this year rather than reverting to lower levels. This means fewer people are subject to the higher AMT rates. The bill also makes other changes, most effective through 2010.

"In (tax year) 2006 a lot is likely to change, but for 2005 some of the basic rules hold because the Working Families Act is an extension of a lot of existing taxes. We will have a lot more clarity for the future by next year, after the election," says Michael E. Kitces, director of financial planning for Pinnacle Advisory Group in Columbia, Md., a private wealth management group with more than $310 million under management.

A major provision of the Working Families Tax Act extends for one year the exemption limits for the AMT. An earlier tax bill had increased the exemption limit to $40,250 for single taxpayers and $58,000 for married couples filing jointly. The 2004 tax bill extends those increased limits, but only for tax year 2005. Without it, the limits would have dropped to the former levels of $33,750 and $45,000, respectively.

The entire tax bill is expected to cost the government $146 billion, although most of the provisions technically are not reductions for taxpayers but rather avoidance of increases that would have taken place. The bill easily passed both houses of Congress, despite objections by some Democrats that it is not paid for with offsets in other programs and will increase the national deficit.

 Although the tax was originally aimed at high-income people who were avoiding paying any income tax, it was never indexed for inflation as the regular income tax schedules are. A taxpayer has to pay the higher amount of AMT or regular income tax. With one indexed for inflation and the other not, more and more middle-and upper-middle-income people are being forced to pay AMT each year. The one-year extension of the higher exemption rates will allow many who otherwise would have been hit to avoid paying AMT for tax year 2005, according to Robert F. Manning, senior executive editor for Tax Analysts, a nonprofit, nonpartisan organization based in Washington, D.C., that studies tax policy.

 "Congress could just index the AMT for inflation, which would help some," Manning says. "But if something is not changed, and exemption amounts revert back to the lower level in 2006 as they are scheduled to do, 90% of the AMT taxes will be paid by those earning $100,000 to $500,000 by 2010. Put another way, about one-third of all taxpayers will be subject to AMT by 2010, and that is not what it was originally intended for."

However, fixing the AMT and making it apply only to its original targets gets more expensive each year and therefore harder for Congress to do, tax planners say.

"The tax act reaffirms some tax provisions already in place, but the impact is to lower revenues for the government and boost debt," says Henry Aaron, senior fellow of economic studies at the Brookings Institution in Washington, D.C. "For taxpayers, the AMT disallows a number of deductions, has one large exemption, and than a proportional tax rate above that. The problem is, because it is not adjusted for inflation, it is pushing more and more people into paying the
AMT rather than the regular tax, and the AMT rates are higher."

The result is the tax reductions passed in 2001 and 2003, touted by President Bush, are for many people largely eaten away by AMT payments, according to David Cay Johnston, author of Perfectly Legal, an analysis of United States tax policies.

Rather than being limited to those in the upper-income brackets, the AMT comes into play for many middle-and upper-middle-income taxpayers who have large deductions under regular income tax schedules, planners warn. Anything that lowers taxes under the regular income tax schedule could push a taxpayer into the AMT, since whichever payment is higher is the one due.