11/16/12 – Something Taxpayers Should Know About the Fiscal Cliff

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Nov 16, 2012 9:47:16 AM

and tagged Fiscal Cliff

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I am not a tax expert, and I don’t even play one on TV. In fact, I’m normally reluctant to weigh in on taxes, but there is one issue that doesn’t seem to be getting the attention I think it deserves: the expansion of the alternative minimum tax, better known as the AMT.

Briefly, if you are above a certain income threshold, you have to calculate your tax bill both the normal way and under the AMT rules, which limit certain deductions and typically result in a bigger tax hit. You then pay the higher of the two. This can be a nasty shock if you’re not expecting it, as the additional liability can run into the thousands.

The AMT was created to ensure that high-income households could not use deductions and exemptions to reduce their tax bills too much—that is, to ensure that everyone paid their fair share. The problem is that the base where the AMT kicked in was not indexed for inflation, so every year more people would be considered “high income” and subject to the AMT. Congress has acted every year to address this and adjust it on an ad hoc basis, but the problem still remains.

Which brings us to the present. If we go off the fiscal cliff, literally millions of additional households will be subject to the AMT and will find their tax bills increasing, probably substantially. What’s more, this may well come as a total surprise in April 2014, as their tax preparers run both calculations and deliver the bad news. For people who do their own taxes and don’t realize they have to run both sets of numbers, the news could be even worse when the IRS catches them and assesses interest and penalties.

This is not only an economic nightmare, but a political one as well. Having started companies and filed quarterly returns, I’ve often thought that the only thing that allows out tax system to work is paycheck withholding. If taxpayers had to write a check every quarter, the way the self-employed or business owners do, there would be a revolution. Putting the AMT front and center like that, and requiring millions of households to write a large check, might do the same.

I don’t think there’s anything the average reader of this blog can do about it—although, certainly, if a Congressperson is reading this, a fix should be a high priority. I mention it, first, as something that should be discussed more and, second, as an example of the kind of unintended and destructive consequences we will face if we go off the cliff. Pay attention, as there will be more of them.

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