Friday, March 11, 2005

... it's that time of year again.

Case of Vanishing Deductions: Alternative Tax Called Culprit

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The valuable federal tax deductions that people receive for paying local and state taxes have quietly started to vanish for many households, raising the cost of living in places like New York, Massachusetts and California, already among the nation's most expensive.

The culprit is a once-obscure federal tax provision known as the alternative minimum tax, which was created in 1969 to ensure that a relatively small number of wealthy people did not use loopholes to avoid paying taxes. But it is increasingly being applied to families with incomes of $75,000 to $250,000 a year who claim relatively high deductions - like the ones for property taxes, state and local income taxes - and the exemption for children. When it does apply, it cancels some of those deductions.

Barring a change in the law, almost 19 million taxpayers will be subject next year to the alternative minimum tax, or A.M.T., up from roughly 3.4 million this year and 1.3 million in 2000, according to the Tax Policy Center, a Washington research group whose calculations on this issue are widely accepted.

The shrinking of the deduction for local taxes for millions more families in the next few years has the potential to cool price increases in thriving real estate markets, particularly in the Northeast and on the West Coast.

About half the people paying the alternative minimum tax in recent years live in one of four states - California, Massachusetts, New Jersey and New York - accounting for almost a quarter of the nation's population.

"If you're just talking about a rank-and-file working couple, they're getting hit in these towns," said Timothy F. Allen, a tax preparer in Belmont, Mass., about many of the middle- to upper-middle-class two-income families he serves in the Boston suburbs. "It grabbed me in 2004, and I was kind of surprised.

"The A.M.T. effectively sets up a parallel tax system for all households, in which few deductions are allowed. Taxpayers whose alternative tax is higher than their regular federal income tax must pay the alternative one.

The taxes that people pay to their local and state governments become a deduction in the standard federal system but not in the alternative one. The higher those deductions, the more likely a household is to fall into the A.M.T.

A commission appointed by President Bush to make recommendations for overhauling the tax system met Wednesday in Washington for the first time, with a deadline of July 31 to issue a report, meaning there will not be a change before this year's deadline for filing 2004 taxes.

While many powerful members of Congress have called for a change, the administration's proposed budget did not offer one.

Almost any plan to ease the tax without raising other taxes would cost the Treasury hundreds of billions of dollars in revenue over the next decade, worsening the federal budget deficit.

Some tax experts say the relative simplicity of the A.M.T. offers a good model for tax reform.
The problem, people of almost all political viewpoints say, is the combination of the A.M.T. and the regular federal income tax.

"It makes the system completely opaque," said Pamela F. Olson, an assistant Treasury secretary for tax policy in Mr. Bush's first term and now a partner at the law firm of Skadden, Arps, Slate, Meagher & Flom."People have no idea what their taxes are going to be, and it takes back things we put in the code.

"The interplay between local taxes and the A.M.T. has in effect become a face-off between two forces that many economists consider unsustainable: the rising federal budget deficit and the continuing leaps in home prices.

Left unchanged, the alternative tax would produce more revenue by 2009 than the ordinary federal income tax, according to the Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute.

"It's an enormous issue," said Connie Mack, a former Republican senator from Florida who heads the commission Mr. Bush appointed to study tax reform, "and one we're clearly going to take a look at. "If the tax remains, living in many localities will become more expensive, potentially curtailing the growth in home values that has been a major boon to the economy recently. It could also create pressure to cut property taxes, the major source of public education funding in many communities.

Without a change in the A.M.T., 30 million taxpayers are likely to face it five years from now, many of them concentrated in high-tax states.

"Taxes do affect the market," said Raymond G. Russolillo, who oversees tax-consulting services at U.S. Trust in New York. "I suspect it will affect behavior at some point."Michael Levin, 52, is an anesthesiologist in Manhattan, married, with a daughter in high school and a son in college.

He does not use tax shelters or take big deductions from investments, he said. But his income, while not outsize by New York standards, is relatively high and he owns a condominium in the West Village section of Manhattan. As a result, he fell into the A.M.T. last year, costing him almost $5,000 in additional taxes.

"When I first heard about it," Dr. Levin said, "my understanding was that the concept was to prevent fat cats from not paying any taxes.But it's killing the middle class as well.

"The alternative minimum tax began in 1969, after Joseph W. Barr, the departing Treasury secretary under President Lyndon B. Johnson, told Congress that 155 wealthy families had used loopholes to avoid paying any federal income tax in 1967. Today, it exempts a standard amount of income - as much as $58,000 for a married couple this year - and allows further deductions for mortgage interest and contributions to charity.

"The Republican majority may not be acting on it because they see it as a red state-blue state issue," Representative Carolyn B. Maloney, a New York Democrat, said.

The A.M.T. is just one of many factors influencing the housing market; the effect of mortgage rates and the ups and downs of the economy certainly outweigh it in importance. But specialists foresee taxes becoming a more prominent factor in real estate markets as the alternative tax affects many more homeowners.

Carlo and Chris Marano bought their home in Danbury, Conn., for $265,000 in 1992. Marano said, and "we have significant space we don't need." But the Maranos - he is self-employed, helping design employee benefit plans, and she works for an accounting firm - could not find any house around Danbury that they wanted and that was inexpensive enough to make a move seem worthwhile.

Summarized by Copernic Summarizer

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