The AMT day of reckoning quickly approaches

It is called the Alternative Minimum Tax (AMT) and if you haven’t met it yet, you will likely do so before long.

This ticking time bomb was enacted in 1969 to force a relatively small number of taxpayers using exotic tax shelters to pay some minimum amount of federal income tax each year. In yet another manifestation of†Congress’s fiscal “genius,” the legislation was not indexed for inflation.

The result has been a snowballing effect of more and more middle income families getting hit by this pernicious tax.

Congress has painted itself into a corner by never addressing the flaws in the AMT during the last 38 years. Part of the reason for that lack of action is that the AMT poured money into the federal treasury somewhat unnoticed until the cumulative toll of inflation is now resulting in millions of families being hit with the tax.

Congress now realizes that it has a huge problem on its hands.

This is not going to be an easy problem for Congress to fix. In 1990, only 200,000 taxpayers were hit by the AMT. By 2006, 4 million were paying significantly higher taxes due solely to the AMT.

If the temporary “fixes” to the problem enacted in the last few years are not extended to the 2007 tax year, some 22 million taxpayers will be slammed by the AMT when their tax bill comes due. Likewise, the windfall to the federal treasury from the AMT was $2 billion in 1990. That expanded to $22 billion in 2006 and would be $65 billion for 2007 if nothing is done.

In addition to the absence of an inflation index, the other major factor driving the increase in the number of taxpayers subject to the AMT is the federal tax cuts enacted in 2001 and 2003.

It is a cruel irony that cutting the taxes of most Americans ensnared more of them in the tentacles of the AMT. In fact, many taxpayers still don’t know that they actually have to prepare two tax computations each year, the regular Form 1040 calculation and the AMT alternative as well, and then pay whichever is higher.

Members of Congress in both parties know that, from a political standpoint, there are no easy options to address this problem. Either individuals’ taxes have to go up exponentially or as much as $1 trillion dollars needs to be cut out of the budget during the next decade to offset the revenue loss that would result from eliminating or significantly reducing the AMT.

Of course, if Congress allows the 2001 and 2003 tax cuts to expire, the significantly higher taxes that households would pay would actually reduce the number of taxpayers subject to the AMT. Most of them would not be happy with that potential “solution” to the problem.

The overall budget mess complicates the desire of Congress to eliminate or drastically reduce the AMT. In a few years, the Baby Boomers will create a surge in Social Security and Medicare enrollments, rapidly escalating costs in both of those systems. The previously mentioned tax cuts did promote the economic expansion that has created record levels of federal revenue growth. Simply not renewing the tax cuts when they expire in 2010 may not give Congress the money necessary to eliminate the AMT. Higher tax rates quite likely will mean a more sluggish economy and lower tax collections by the government.

Congress did little to fix the AMT problem in the last 40 years. Now it will pay politically for its lack of action.