Tax Simplification, Republican Style: Return of the AMT

Early on the morning of December 2^nd, Republicans in the Senate passed a tax bill that differed significantly from the bill posted in early November (a copy of the bill text is here; as of 12/7, there was as yet no plain English description of the changes posted at jct.gov). Notably, the revised bill restored the Alternative Minimum Tax (AMT), which had been eliminated in the early versions of both the House and Senate bills.

The Senate bill does make two changes to the individual AMT: the AMT exemption is increased, and the point where that exemption phases out was also increased (see below for the impact).

The question of interest, as in all these recent posts, remains: Will you pay more or less in taxes under the new Republican regime?  Short answer: the change in the AMT produces a picture of almost Byzantine complexity. Some current AMT victims will see taxes go up, others will see their tax burden go down.  Read on for the details.

The AMT (“Attack the Middle Tax”)

By “you,” I mean current AMT victims. That means almost all married couples with incomes between $200,000 and $500,000, in states like California or New York; many such families, in states like Illinois, Massachusetts, or New Jersey; and very few such families in states like Texas or Florida. (Assumption: family of four, with two children over 17.)

The effects of the Senate bill are laughably complex.  Four values have to be computed before we can answer the question, Will you pay more?

1. Your estimated regular tax liability in 2018 under the existing regime
2. Your estimated AMT liability under the existing regime
3. What your regular tax would be under the new Senate bill
4. What your AMT would be under the Senate bill

Under the AMT, you will pay the greater of (1 vs. 2) or (3 vs. 4), depending on whether the Senate bill becomes law.

This raises the possibility that under the Senate bill, some taxpayers will drop out of the AMT in 2018 (campaign slogan: “we rescued you from the AMT”), but pay more dollars in taxes, because their regular tax liability is so much higher (attack ad: “Republicans despise blue state voters”).

Other couples will pay the AMT under either regime, but the Senate changes will lower their AMT burden by thousands of dollars.  In fact, as shown below, some affluent blue state voters will save thousands of dollars.  Surely an unintended consequence?

Absurdly, the likelihood and magnitude of a tax cut / hike under the Senate bill bear no linear relationship to income.

Tax simplification?

Three sample cases

Case #1: California, New York City, District of Columbia …

I start with a hypothetical couple in California. Assumptions are given in a block at the end of the post. These assumptions provide a base of comparison across income levels and states.  Later I’ll consider Texas etc. and New Jersey etc. cases.  Last, all the scenarios assume an ordinary victim of the AMT, who had the misfortune to make too much, but not quite enough, from salaries and bonus, with no special forms of income or special deductions.  You know who you are.

The three sample families will have estimated AGI in 2018 of $225,000, $362,500, and $700,000. These amounts were selected after examining effects for the whole range, from $200K to $1M and more. The first income is near the floor of where the AMT currently kicks in; the second is near the painful middle of the current AMT structure; and the third is beyond the point where the AMT tax credit presently takes hold (e.g., Form 8801, see this post), markedly reducing the burden of the AMT after that income threshold is reached (as I said, AMT = attack on the middle tax).*

*But I’m going to ignore any possible AMT credit in these analyses; some taxpayers with AGI above $500K will be able to save more than stated below by the Form 8801 route, but … KISS principle.

Projected for 2018	Cases
AGI:	$225,000	$362,500	$700,000
Mortgage interest	$22,500	$36,250	$40,000
Property tax	$7,493	$12,071	$23,310
State income tax	$13,651	$23,563	$60,485.55
(Old) regular tax	$32,755	$66,693	$176,835
(Old) AMT	$32,734	$74,378	$177,778
(Senate) regular tax	$35,881	$64,979	$178,979
(Senate) AMT	$23,823	$65,138	$180,970
Senate tax cut (hike):	($3,126)	$9,240.00	($3,192)
*The italicized number is the greater of regular and AMT, under new and old regimes; subtracting new from old yields the tax cut / hike dollars

 

Implications

1. Blue state taxpayers numerous in suburban voting booths (income ~$200,000) will pay so much more in regular tax that they will no longer owe AMT—but will still see a tax hike, net, under the Senate bill.
2. High income professionals and low-level executives, at income ranges not common in any voting district (income ~$700,000) will also see a modest tax increase in these deep blue states; in their case, because the AMT structure was not relaxed enough. Exception: if they have stored up ample Form 8801 credit, and depending on how the final text of the bill treats those credits.
3. Blue state taxpayers common in a few, very affluent coastal districts (income ~$300K to $500K) will see a significant tax cut, because the positive changes to the AMT structure overwhelm the negative changes to the regular structure.

Consulting the underlying spreadsheet with the full range of values, I see that the tax hike goes to zero at about $262,500, for Californians and New Yorkers; the tax benefit then rises quickly from there and begins to plateau at about $350,000.  Next, the benefit maxes out near $500,000, and then goes negative and becomes a tax hike after $600,000; after which, the total tax hike grows larger and larger, because the AMT typically ceases to be a factor, and because repeal of the SALT deduction punishes the W-2 millionaire more and more with each million.

Hard to see any political rationale for this distribution of benefits…

Case #2: Texas, Florida, etc.

Now let’s jump to the other extreme: the red state taxpayer in a Texas or Florida. Here there is no state income tax, but I’ll otherwise keep all assumptions the same (property taxes tend to be high in these states, so even though houses cost less, the assumed amounts from California and New York still hold). Note that the December 2^nd Senate bill limits the deduction of property taxes to $10,000.

Here are the results:

Projected for 2018	Cases
AGI:	$225,000	$362,500	$700,000
Mortgage interest	$22,500	$36,250	$40,000
Property tax	$7,493	$12,071	$23,310
State income tax	$0	$0	$0.00
(Old) regular tax	$36,577	$74,469	$200,787
(Old) AMT	$32,734	$74,378	$177,778
(Senate) regular tax	$35,881	$64,979	$178,979
(Senate) AMT	$23,823	$65,138	$180,970
Senate tax cut (hike):	$696	$9,331	$19,817
*The italicized number is the greater of regular and AMT, under new and old regimes; subtracting new from old yields the tax cut / hike dollars

 

Now that’s a Republican tax bill!  In Texas et al., the more you make, the more you save under the new regime, with the savings mounting into the tens of thousands of dollars as income passes $500,000.  Most of these folks were not in the AMT zone, or not by much; and repeal of the SALT deduction doesn’t hurt them, hence, they take it to the bank. On the other hand, many of these affluent Texans will experience the dubious pleasure of being subject to the AMT for the first time; but only in small amounts.

Here the Republican promise is fulfilled: tax cuts for everyone! (And bigger cuts for those who make more.)

Case #3: New Jersey, Connecticut, Illinois, etc.

Next we’ll take the middle case, with New Jersey as the poster child.  All assumptions are the same, except that here we estimate a state income tax burden, after mortgage and property tax deductions, of 5% at lower levels and 6% at higher levels.

Projected for 2018	Cases
AGI:	$225,000	$362,500	$700,000
Mortgage interest	$22,500	$36,250	$40,000
Property tax	$7,493	$12,071	$23,310
State income tax	$9,750	$17,280	$38,201.40
(Old) regular tax	$33,847	$68,767	$185,660
(Old) AMT	$32,734	$74,378	$177,778
(Senate) regular tax	$35,881	$64,979	$178,979
(Senate) AMT	$23,823	$65,138	$180,970
Senate tax cut (hike):	($2,034)	$9,240	$4,689
*The italicized number is the greater of regular and AMT, under new and old regimes; subtracting new from old yields the tax cut / hike dollars

Here the pattern of gains and losses is the same as in California/New York, except the most affluent families still save (some) money under the new regime.  The lower boundary of the upper middle class in New Jersey et al., earning in the low $200K range—the most numerous of the income groups in terms of voters—still takes it on the chin.

But the underlying spreadsheet shows an even more bizarre pattern. After $700,000, the tax benefit climbs again, then plateaus about $1M, then drops off again, disappearing about $2,000,000, and reversing into a serious tax hike after that point, as with California W-2 millionaires, but kicking in at higher values, again driven by SALT repeal.

If Republicans had wanted to withhold rewards from high income professionals in New Jersey making near $700,000, but also reward Wall Street traders and salespeople pulling in near one million dollars, while still punishing managing partners making $5 million to $10 million, the new regime is beautifully designed.

Conclusion

Although Republicans clearly like Texans the best, they really dislike suburban affluent voters in states like California and New York, and they don’t much like the suburban affluent voter in states like New Jersey either. Plus, they despise wage millionaires, e.g. CEOs and VPs, in California and New York, and in New Jersey as well. Remarkably, Republicans show an unexpected soft spot for highly successful professionals among the coastal elite, those earning between $350,000 and $500,000 (Silicon Valley, Wall Street, Hollywood), cutting these folks in for almost the same dollar savings as Texans in that range.

This makes no sense.

Assumptions

1. Interest paid on the mortgage equals 10% of Adjusted Gross Income (corresponding to a mortgage at 4% against an amount equal to 2.5X AGI, or a $500,000 mortgage for a family making $200K). Deductible mortgage interest maxes out at $40,000 (4% of $1M).
2. Property tax equals 3.33% of AGI (corresponding to a house worth about 3.33X AGI, or $667,000 for a family making $200,000; less, in states outside California, with high property tax rates in those states producing the same dollar deduction).
3. State income tax: for Californians et al. this runs from 7% of AGI after deducting mortgage interest and property tax, for the lower range, to 9%, for the upper end; for New Jersey et al. , 5% at the lower range to 6% at the upper end; and for Texans et al., zero percent throughout.

You’ll have to trust me that these amounts are a reasonable interpretation of California’s progressive rate structure, and that these should be not too far off the mark in New York city; likewise, the New Jersey values will be close for Illinois, Connecticut, etc.

4. Included in the calculations are the effects of (old) phase-out of personal exemptions, (old) phase-out of deductions,* changes in new regular tax rates per the Senate; and also, changes in new AMT exemption and exemption phase-out per the Senate, and elimination of personal exemptions and elimination of the deduction phase-out per the Senate.

*Little known fact: state and local taxes ARE deductible on the AMT, to just the extent they were NOT deductible for regular tax, as triggered by the phase-out of itemized deductions.

You can enter your own values in this spreadsheet, AMT calculations under Senate December 2nd bill if you want to customize the analysis for your personal situation.  And again, I’m only concerned with ordinary taxpayers who get their income on a W-2.

If you do download the spreadsheet, be careful about entering new values to customize it; you may have to adjust the tax calculations to refer to a different rate bracket (brackets listed below scenarios).  If you don’t understand how tax is calculated off a rate bracket table, I recommend not downloading the spreadsheet—too much risk of sorcerer’s apprentice effects. Speak to your tax professional instead.

Speaking of which, here’s a pop quiz for tax aficionados:  Explain the bizarre pattern of results laid out above in terms of the phase-out of the AMT exemption combined with the effect of lowering regular rates while holding AMT rates constant.

In the same vein, if you find an error or question the legitimacy of any of my assumptions, please post a comment.