Bush's Capital-Gains Tax Cut May Bypass Millions of His Backers
July 24 (Bloomberg) -- When Jeff Trinca liquidated part of his stock portfolio to satisfy a divorce decree in early 2005, he calculated he would owe 15 percent tax on his capital gain. A year later, he got a nasty surprise: a much higher bill from the Internal Revenue Service.
If anyone should have known what to expect, it's Trinca: He's a Washington tax lobbyist. Still, he lives in one of some 2 million U.S. households that were denied the lower rate on capital gains last year because of a little-noticed quirk in the alternative minimum tax, originally created almost four decades ago to make sure a much smaller number of affluent Americans were paying their fair share.
Instead of paying the 15 percent rate established by President George W. Bush's 2003 tax cut, Trinca, 45, and other taxpayers with incomes between $150,000 and $400,000 are required to pay rates of up to 22 percent on their investment income. If left unchecked, the AMT anomaly may deprive millions more six- figure earners -- 60 percent of whom voted for Bush in 2004, when he won 51 percent of the vote nationwide -- of the low rate.
Affected taxpayers have a right to be angry, given the emphasis placed on the lower rates by Bush and congressional Republicans, says Nina Olson, the national taxpayer advocate at the IRS.
``In this case, you had a lot of placing of importance on lower rates on capital gains and its importance to the economy, yet the AMT undermines that policy,'' Olson said in an interview. ``When people make a decision based on a stated policy and end up paying higher taxes, of course they're going to feel frustrated.''
Higher Rates
Last year, 37 percent of all long-term capital gains were taxed at rates higher than the 15 percent Bush signed into law.
The alternative minimum tax was created in 1969 after it was revealed that 155 people with incomes above $200,000 -- $1.1 million in today's terms -- claimed enough exemptions, credits and other deductions to allow them to owe no tax.
The AMT disallows most of those benefits in favor of a flat exemption, currently $62,550 for a married couple, and imposes a separate rate structure with rates ranging from 26 to 28 percent on any remaining amount. Affected taxpayers must calculate their bill under both systems and pay whichever is higher.
Because the AMT was never indexed for inflation, it affects more and more people as incomes rise and ordinary tax rates fall. It especially ensnares large families and those who live in high- tax states, because the AMT doesn't allow commonly claimed deductions for children and state and local taxes.
Few Millionaires
Few millionaires pay the AMT because their liability under the regular system's top tax rate of 35 percent usually exceeds the amount imposed by the AMT, which has a top 28 percent rate. And because capital-gains income itself isn't an AMT trigger, millionaires who live off their investments generally still pay the 15 percent rate on their gains.
The capital-gains problem usually arises when a household has a combination of relatively low income from wages, high income from capital gains and deductions that can't be claimed under AMT. In addition, some residents of states and cities with high income taxes -- such as California, New Jersey, New York and the District of Columbia -- pay higher rates of federal tax on their capital gains than they paid before Bush took office.
The result is that some affected voters are ``upset by clueless Washington politicians claiming credit for low capital- gains rates, knowing their own situation is very different,'' says Henning Bohn, an economics professor at the University of California, Santa Barbara. He figures that Californians who pay the AMT will effectively pay 26.5 percent federal tax on their capital gains, plus an additional 9.3 percent state income tax.
Abolishing the AMT
Senate Finance Committee Chairman Charles Grassley, an Iowa Republican, and the panel's top Democrat, Max Baucus of Montana, have proposed abolishing the AMT. Grassley says the problem facing six-figure earner-investors is that the AMT ``has grown like a weed with tentacles around other parts of the tax code.''
Bush isn't interested in changing the AMT unless the effort is part of a broader overhaul of the entire tax code, White House Office of Management and Budget Director Rob Portman told reporters this month in Washington when he released the administration's mid-session budget numbers.
Last year, the administration postponed an effort to restructure the tax system until next year at the earliest.
`A Very Big Deal'
Ralph Tower, a professor of taxation at Wake Forest University in Winston-Salem, North Carolina, says that without decisive congressional action on the AMT, more and more investors will be caught by the capital-gains surcharge. ``It's a very big deal,'' he says. ``It's very difficult for lay people to figure out.''
The stealth capital-gains tax increases may be contributing to a surge in tax revenue the administration says will narrow the federal budget deficit this year by 30 percent to $296 billion. The staff of the nonpartisan congressional Joint Committee on Taxation estimates nearly half of the $405 billion in long-term capital gains reported to the IRS last year came from Americans who pay the alternative minimum tax.
About 15 percent of those gains were taxed fully at a 21.5 or 22 percent rate because of the surcharge, and 37 percent were taxed between 15 percent and 22 percent. The rest qualified for the 15 percent rate.
``It's possible that the revenue surprise is the result of the most successful bait-and-switch operation the Congress has ever devised,'' says John Buckley, the chief tax counsel to the Democratic staff of the House Ways and Means Committee.
Resignation
John Pearson, a certified public accountant in Norwalk, Connecticut, says his clients aren't so much angry with the government as disappointed that they didn't get the tax cut they were led to expect. ``It's kind of like resignation: `Here's another case where we didn't get what we were promised,''' Pearson says. ``It was a great way to give a tax cut, but not really.''
For Trinca, the Washington tax lobbyist -- who as a congressional aide once worked on efforts to overhaul the IRS -- the result was thousands of dollars in extra taxes and penalties. ``It was enough that it hurt,'' says Trinca, who works for Van Scoyoc and Associates. ``It was not an easy check to write.'' |
