Tax Increase Prevention Act of 2007
January 6, 2008
Jeff: On December 26th Congress gave the American people a belated Christmas gift, called the Tax Increase Prevention Act of 2007. This new law will save taxes for millions of Americans by reducing the impact of the Alternative Minimum tax. Here to explain is attorney Michael Solomon.
Jeff: What is the alternative minimum tax?
Michael: Jeff the alternative minimum tax was actually passed way back in 1969. Congress wanted to make sure people with higher incomes could not evade paying income tax. The Alternative Minimum Tax was designed to catch approximately 300 people who were using various tax shelters and techniques to avoid paying income taxes. Unfortunately the law has never been adjusted for inflation. So what started out as a law to catch a few hundred people has now grown into a law that would have increased taxes for 20 million people this year. The new law changes reduce the number of people covered by the Alternative Minimum Tax to 4 million people.
Jeff: explain how the alternative minimum tax works.
Michael: It's complicated, but basically the alternative minimum tax is a parallel tax system to the regular income tax that most people are familiar with. What Congress did was take your regular taxable income and add back to it some special tax breaks the tax code provides and reduced some deductions allowed under the tax code. After all of these add backs and reduced deductions, you calculate your AMT tax and if it is higher than the regular tax, you pay the alternative minimum tax. Basically if you take advantage of too many of the tax breaks Congress has given, then they take the benefits away from you.
Jeff: What are some of the tax benefits that Congress takes away under the AMT?
Mike: For example:
- Real property taxes, state and local income taxes and sales taxes may be deductible as itemized deductions on the regular tax but are not allowed in determining the alternative minimum tax.
- Normally you can deduct medical expenses in excess of 7.5% of adjusted gross income. However you can only deduct medical expenses in excess of 10% of your adjusted gross income for the alternative minimum tax.
- You are not entitled to personal exemptions or the standard deduction when calculating AMT.
- Tax exempt interest on certain types of bonds are added back to income under the AMT. This might be tax exempt bonds issued by state or local governments for certain government projects like schools or utilities.
Jeff: So how did this new tax law solve the problem?
Michael: Under the old law, the AMT kicked in with income of $33,750 if single, $45,000 for married couples. Now, the income levels have been increased to $44,350 for singles, $66,250 for married couples. While the increase in income levels may seem modest, it protects 16 million people from having to pay the higher AMT for 2007.
Jeff: Is the problem solved?
Mike: Congress did solve the problem temporarily; the new income levels are in place for one year. So Congress will have to deal with this again before next year. But the law also created a new problem because Congress waited so long to change the law, millions of taxpayers who claim education credits, residential energy credits, child and dependent care expenses, or a mortgage interest credit will have to wait to file their returns while the IRS changes the forms.
The IRS also warned that if you use tax software to prepare your tax returns, make sure that you update the software in January before you file and don't rely on government printed forms mailed in December because they use old AMT calculations.