posted on:  11/16/2006     revised: 3/9/2010

A number of taxpayer advocates including Fairtax.org promote the value of revising out tax system to a simple, level basis known as a "flat tax" that cannot be manipulated.¹ Yet acceptance of this concept has been slow. It may never come at all. Or is it really already here and we simply do not recognize it?

A section of the tax law known as the Alternate Minimum Tax was introduced in 1969 that affected very few people and remained obscure for decades. Yet within the next few years, this will be the effective basis of income taxation for 33% of all taxpayers! Since the system does not affect people with incomes below about $50,000, the percentage of higher income people (presumably most of the people reading this) will be much higher.

Here's the thing about the AMT: it is very difficult to do effective tax planning. For example, I am usually able to help clients get their effective tax rate below 10% of gross income; that is, until they get caught in an AMT situation. Then all bets are off. Effective overall tax rates will easily climb to the mid teens. Those most likely to be affected are investors in rental real estate, small business owners, two income families who file taxes separately, executives with stock options and investors who borrow money and have heavy interest expenses.

Occasionally I see articles on the topic of planning strategies for the AMT, but in reality there is very little that can be done. First of all, an AMT liability is usually not apparent until after the end of the tax year. Even when it is visible, seldom would this knowledge affect the chosen transactions or course of action. (Economists would call this a "behavior neutral" tax policy). One recent article quoted an economist saying that clients should consult a tax adviser before year end to make adjustments that would minimize the effects of the AMT. It sounds good on the surface, but I suspect that less than one in ten tax advisers would be able to come up with a savings that would justify a fee for a few hours of their time.  Many advisers just are not in tune with the issue - and I put myself in that category. No mater how carefully I try to watch out, he AMT sneaks up on me almost every time. One practical issue is that today's tax planning software is not good at catching approaching ATM risks. (Hopefully that will improve very soon).

I would guess that 3/4 of the people who engage a professional for tax planning would basically be told "all those strategies we used in the past no longer apply". This could happen as soon as 2010 if no changes are made in the AMT law. The AMT is a great way for the new Congress to raise taxes without passing a single new law. Based on these observations, and what has been in the press lately (especially post-election Nov. 2006), we are likely to see the AMT stick stay unmodified for the long term.

Footnote

¹For the record, I support the "fair tax" proposal even though it would be financially damaging to my income as a tax adviser, my family's overall net after-tax income and my clients' collective net worth. There are some very good economic arguments for avoiding the flat tax approach, but still I believe that it is clearly the best route for our country.

keywords:   Flat Tax, Fair Tax, Tax Increase, alternate minimum tax, AMT

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Copyright 2010 by Tony Novak. Originally produced and published for the "AskTony" column syndication prior to 2007. Edited and independently republished by the author in March 2010. All rights reserved.