Indexfundfan\’s blog (new URL is Indextown.com)

July 20, 2006

Regressive tax brackets under AMT

Filed under: Finance — indexfundfan @ 11:20 am

The alternative minimum tax or AMT has been affecting more and more Americans in recent years. Originally designed as an alternative tax for the very rich who avoided paying tax by claiming various deductions, it is now becoming more and more of a middle and upper-middle class tax. The main reason is because the income thresholds for AMT are not indexed for inflation, quite unlike the regular income tax brackets.

Most people must have heard that the AMT tax brackets are ‘only’ 26% for incomes below $175k or 28% for incomes beyond $175k. This is not quite true. AlvinSch on Diehards forum has raised the issue a few times that AMT brackets are in fact regressive if your income is within the range of $150k and $400.2k (was $382k in 2005, see CNN article: “How the new tax law affects you”, May 17, 2006).

The reason why the effective AMT brackets are not 26% and 28% is because the effect of a phase-out of the personal AMT exemption for incomes above $150k by a quarter of a dollar for every additional dollar earned is ignored. The effect of the phase-out is to increase the tax rate by a quarter of 26% or 28% for incomes in the phase-out range.

Overall, the effective AMT brackets for a couple filing jointly for tax year 2006, taking the phase-out exemption into account, is as follows:

  • below $62.55k : 0%
  • $62.55k to $150k : 26%
  • $150k to $220.04k : 26% + 26%/4 = 32.5%
  • $220.04k to $400.2k : 28% + 28%/4 = 35%
  • beyond $400.2k : 28%

As we can see, the AMT brackets are regressive and actually lower for the very rich with incomes beyond $400.2k.

Notes:

1) The income of $220.04k is the point at which AMT changes from 26% to 28%. This number, call this Y, occurs when your ordinary income, reduced by personal exemption, is $175k. The calculation to derive Y is as follows:

Y – E = 175000 where E is the personal exemption.

Y is above $150k and E is therefore subjected to the phase-out:

E = 62550 – 0.25(Y-150000)

Combining,

Y – (62550 – 0.25(Y-150000)) = 175000, giving Y = $220,040.

2) The number of $400.2k is the point at which the personal exemption completely disappears. This number is given by $150k + $62.55k/0.25 = $400.2k.

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1 Comment »

  1. […] In an earlier post, I wrote about the regressive tax brackets when evaluated under the AMT structure. In this post, we will consider how these AMT brackets affect the yield of various flavors of tax exempt money market funds, looking specifically at the case of an investor domiciled in California. […]

    Pingback by Indexfundfan’s blog » Impact of AMT on tax exempt funds — August 18, 2006 @ 1:13 pm


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