Trump Tax Return Highlights Alternative Minimum Tax Quandary

The tax that ensures the ultra-rich like Donald Trump pay at least a minimum tax is also described as a "Frankenstein monster" to middle-class families.

Trump paid federal income taxes in 2005 of $36.6 million, of which $5.3 million was for regular income tax and $31.3 million was for the lesser-known alternative minimum tax, or AMT, according to tax expert and journalist David Cay Johnston.

The $5.3 million the Trumps paid under regular income taxes, as measured against cash income of almost $153 million declared that year, generated the Trumps a federal income tax rate of just 3.48 percent.

From the government’s point of view, the AMT did as it was designed: It hit a very high-income earner in a way the regular income tax system couldn’t because of exemptions and deductions.

Thanks to the AMT, the Treasury collected $31.3 million and the Trumps ended up paying a tax rate of 24 percent on their income of $153 million, a rate still relatively low but far higher than it would have been had it not been for the AMT.

No surprise, then, that Trump has called for the AMT to be abolished, but he’s not alone; many financial advisors feel the same way as more middle-income taxpayers get hit with the AMT.

“It is neither alternative, nor minimum, but mandatory and maximum,” said Leon C. LaBrecque, a CPA and financial planner in Troy, Mich.

He calls the AMT “mislabeled and onerous,” the “Frankenstein monster of tax planning.”

Critics say the AMT is in desperate need of reform and have called for everything from abolishing the tax to raising income thresholds.

Proponents point to the AMT as a last-ditch blunt instrument to extract from wealthy earners a meaningful portion of what they owe.

An (Outdated) Vehicle to Target the Superrich

Originally introduced in 1969 and subsequently amended, the AMT was designed to target the ultrarich, people with annual incomes of $200,000 annually, since they avoided federal income taxes thanks in part to obscure deductions.

($200,000 in 1969 had the equivalent buying power of $1.5 million in 2017.)

But as wages rose, as Congress cut regular income taxes, and as the AMT wasn’t indexed for inflation - until 2016 - middle-class households found themselves saddled with the AMT and its 26 percent to 28 percent flat rate with higher frequency.

Taxpayers affected by the AMT rose from fewer than 200 in 1969 to 4.8 million in 2017, according to Tax Policy Center estimates.

“Rather than targeting the highest income earners, the AMT is disproportionately hitting many middle-class families,’ wrote George Papadopoulos, a fee-only wealth manager in Novi, Mich., in a Wall Street Journal story last November.

“In practice, AMT is more likely to hit taxpayers with families, those who are married and those who live in high-tax states,” he wrote.

In 2015, married couples with children were seven times more likely than singles to pay the AMT, according to researchers at the Tax Policy Center.

Since taxpayers can deduct state and local taxes under the regular income tax, but not under the AMT, taxpayers in high-tax states were twice as likely to be on the AMT as those in low-tax states, Papadopoulos wrote.

Lower Incomes Affected with Higher Frequency

Only 19.7 percent of households filing 2015 tax returns with incomes higher than $1 million are affected by the AMT, according to researchers at the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.

At the same time, 27 percent of households with income between $200,000 and $500,000 and 59.1 percent of those with incomes between $500,000 and $1 million are affected by the AMT, the researchers found.

So the AMT affects well-off households, but not those with the very highest incomes.

The AMT is also more likely to hit taxpayers with large families, who are married and who live in high-tax states, according to the Tax Policy Center.

“Simply living in states with high tax rates and high property values like California and New York can cause average families to get hit with AMT,” said Nick Holeman, a fee-only planner with the online financial advisor Betterment.

LaBrecque points to one of the ironies of the AMT.

“With normal income taxes, we are trying to cut taxable income, but once AMT is in effect, we usually try to increase income to get out of it,” he said.

Few tax experts expect AMT to disappear as it generates tens of billions of dollars in revenue to the U.S. Treasury.

One estimate has the Treasury losing as much as $460 billion in revenue over 10 years if the AMT evaporates.

Opponents and supporters of the AMT agree there is a case to be made for income tax reform, even if it means ditching the AMT and making up for the lost revenue through other means.

“Come up with a cohesive tax policy in the country that makes sense,” LaBrecque said. “AMT doesn't make sense, except as a spurious revenue producer.”

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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