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Tax created to go after rich now hitting middle class
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More and more Americans are required to pay higher tax rates under the Alternative Minimum Tax, which has not changed in the 30 years since it was enacted. (Image courtesy of the IRS)
More middle class Americans are getting hit by a special tax that was designed to make sure wealthy people do not avoid income taxes. Congress came up with the Alternative Minimum Tax in the late 1960s, after learning that a handful of high income Americans were not paying taxes on their earnings. Now, the AMT is beginning to snare moderate-income, middle-class households.

St. Paul, Minn. — It's hard find anyone who thinks the Alternative Minimum Tax remains good tax policy more than three decades after it was established. Experts say the tax, designed to rein in wealthy tax avoiders, has strayed from its original task and is now hitting middle-class Americans. Some call it a pointless complexity to the tax code.

Outside of tax accountants, most people know little if anything about the Alternative Minimum Tax. That wasn't the case in 1969 when Congress created the AMT. The nation was in an uproar after the Treasury secretary told Congress that 155 people who earned more than $200,000 a year were paying no income taxes.

At the time, Yale Law School professor Michael Graetz was working for the Treasury Department in the Nixon administration. He remembers a groundswell of concern following the testimony.

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Image Helped write the AMT

"The outrage was palpable in the amount of correspondence that the Congress received, many letters -- we understood more letters on that issue than they received on the Vietnam War, which was raging at the time," Graetz says.

Designed initially to catch up with only a couple of hundred Americans a generation ago, the tax this year will apply to about three million taxpayers. Many of them are a far cry from the few wealthy tax avoiders the AMT was designed to catch.

The Washington D.C.-based Tax Policy Center says the main reason so many more people are paying the tax now is that the AMT has never been adjusted for inflation. Len Burman, the organization's co-director, says it takes a lot more money to be wealthy now than in did in the late 1960s.

"The problem is growing over time, because inflation pushes more and more people onto the AMT every year," Burman says. "Our estimates are that by the end of the decade, 33 million taxpayers will be subject to the Alternative Minimum Tax. That's the same percentage of taxpayers that's currently taking mortgage interest deductions."

It has become a monster.
- Yale Law professor Michael Graetz

Here's how the AMT works. When you fill out your taxes, no matter how much money you make, you're supposed to check your bottom-line results against Alternative Minimum Tax guidelines. The AMT is calculated without several popular deductions, including deductions for children, for state and local taxes you've paid and for unreimbursed business expenses.

You're liable for whichever tax amount is greater. So if the Alternative Tax calculation produces a higher number than your standard tax total, you have to pay the AMT.

"We're seeing it much more frequently," says Kathy Olson, a tax preparer at NWA Federal Credit Union. "I would say I've probably seen it 10 to 15 times this year. I'd be lucky if I'd see one a year in the past."

More and more, Olson says, Minnesotans are having to pay the AMT because they have more than the average number of children.

Exacerbating inflation's push of more people to the AMT are the tax cuts the Bush administration won from Congress three years ago. Those tax cuts lowered standard tax rates -- but did not cut the AMT. Because you pay whichever tax bill is higher, the lower the standard tax rate, the greater the chance you'll use the AMT.

Gregg Polsky, a tax law professor at the University of Minnesota, says allowing the AMT to morph from a tax on the rich to one on the middle-class is bad policy. But Polsky says politicians have little incentive to correct problems with the tax.

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"If you talk to your representative, if you talk to the president and you ask them about this, they would say to you, it's really bad. And as politicians they'll say it's really bad and it needs to be fixed. But implicit in that is, 'I'm not going to fix it on my watch because it's just too expensive,'" Polsky says. "The estimate to fix the AMT, to put it back in its proper place -- a one-time fix would cost between $600 billion and $1 trillion."

Further underscoring the magnitude of the problem, the Tax Policy Center estimates four years from now it would cost more to repeal the AMT that it would cost to eliminate the federal income tax altogether.

Yale law professor Micheal Graetz, who helped craft the AMT in the late 1960s, say the AMT has suffered from neglect -- and correcting it now would be an arduous proposition.

"The difficulty for Congress is that they're facing very large deficits and it's very expensive to fix, and so it's very difficult to come up with a solution," Graetz says, "It has become a monster."

For the past two years, Congress has kept the AMT at bay for millions of Americans, with stop-gap legislation that's boosted AMT income exemption rates. The first stop-gap patch cost nearly $15 billion. This year's cost nearly $20 billion. Analysts say if Congress continues with short-term fixes, the amounts needed will rapidly increase from there because so many more Americans will be paying the AMT.

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