A tax meant only for the wealthy but that paralyzed much of the middle class for decades has been permanently defanged. Score one, at least, for the 11th-hour fiscal-cliff deal.
The dreaded Alternative Minimum Tax hasn’t gone away. But this law, which has been modified 19 times since 1969, will need no more patches. Like Social Security benefits, the AMT is now indexed to inflation. That means the income threshold for being subject to the AMT will rise automatically each year. If you don’t pay it this year, you won’t pay it next year or any year thereafter — at least not without an income boost that outstrips inflation.
“The certainty this creates is extremely helpful,” says Walter Primoff, director of the professional adviser group at Altfest Personal Wealth Management. It will save millions of households from the headache of preparing for two separate tax liabilities.
Among those who will benefit the most are the self-employed, who must pay estimated taxes four times a year and are subject to penalties for underpayment. It’s also great news for households on the AMT bubble: the permanent patch makes it simpler to shift income and deductions in a way that may let them avoid the AMT every other year.
The AMT has always been targeted at the wealthy who through deductions ended up paying little or no tax. It is a parallel tax calculation that disallows certain exemptions and then assesses a lower marginal income tax rate. Taxpayers in the gray zone must figure their bill the traditional way and the AMT way and pay the higher amount.
To keep the tax trained on the wealthy, taxpayers are allowed an AMT exemption, which decades ago was set at $45,000 — high enough to miss the middle class. But this level was not indexed to inflation, so as median incomes grew in the ensuing years, the threshold hit more and more ordinary households and was threatening to hit more each year. Only through congressional action — virtually every year in recent years — has the exemption been lifted to spare the middle class.
For 2012, the patch lifted the exemption to $78,750 for households and $50,600 for individuals. For the first time, the patch was also indexed to inflation, meaning taxpayers will never again face the uncertainty of a Congress that may or may not take action and possibly subject them to this higher tax.
“Far from perfect, this legislation does include a permanent fix to the ever-growing AMT, giving millions of hard-working, middle-class families certainty that the nightmare of this tax has finally come to an end,” Republican Senator Orrin Hatch of Utah told ABC News.
According to one GOP estimate, 28 million families would have had to pay an average of $3,400 in extra taxes this year without the AMT fix. About 4 million taxpayers owed the AMT in 2011, up from about 1.3 million in 2001, according to the Tax Policy Center.