The AMT: What the battle is about

Congress is trying to amend the tax code to keep millions of Americans from having to pay the alternative minimum tax (AMT).

This past week, House Democrats for a second time approved a bill that among other things, shields millions of taxpayers from the AMT.

The White House, however, has threatened to veto the bill and Republican leadership in the Senate has called the House approach unacceptable.

Q: What is the alternative minimum tax?

A: The AMT is a tax on income calculated by a different method than that used to calculate the standard income tax.

Unlike the standard income-tax calculation, which allows multiple deductions, the AMT calculation is designed to limit deductions.

There are no deductions for children, so families with many lose a substantial tax break. Neither does the AMT allow deductions for state and local taxes, which play an important role in reducing taxes for residents in states that have income taxes.

Q: How does it work?

A: Taxpayers who meet certain income or deduction criteria must calculate how much income tax they owe under the standard method and also how much they would owe under the AMT method. Then they compare the two results and must pay whichever is greater.

To determine what they would owe under the AMT, taxpayers recalculate their taxable income using a different series of steps.

Then taxpayers subtract a single exemption from that income and calculate their tax liability on the difference — 26 percent on the first $175,000 and 28 percent on the rest.

Q: Why was it created?

A: Congress created the AMT in 1969 in response to concerns that 155 very wealthy families were avoiding income taxes by claiming extensive deductions.

Lawmakers hoped that the alternative minimum tax would guarantee that high-income Americans would pay at least a minimum amount of taxes each year.

Q: What is the problem?

A: The tax was not indexed for inflation, so as incomes have increased over the years, more Americans have become eligible to pay the tax. Last year, about 4 million taxpayers paid the tax, compared with about 20,000 in 1970.

Congress has enacted several temporary fixes to the AMT since 1969 to spare middle-income taxpayers. The most recent fix has expired. If a new one is not enacted, the AMT could hit as many as 23 million taxpayers next year, some with incomes as low as $75,000.

And Democrats and Republicans are hung up in a debate about whether to replace the $50 billion the federal government would not collect from the AMT next year if the law is changed.

The House Democratic plan offsets the $50 billion cost by raising the tax rate on some investment-fund managers and partners in private-equity firms, many of whom make millions of dollars but pay only a 15 percent tax rate on much of their income, which they classify as capital gains. If they were subject to the standard income tax, they would pay a 35 percent rate, like other high-income Americans.