Ninety days and counting until the 2001 Tax Act sunsets. Expect tax rates across the board to increase on January 1st unless new tax rules are enacted. Congress recently warned us, however, that they will not even take up extending the current tax rules into 2011 until after the November mid-term elections. Here is what you can expect for 2011 tax rates assuming Congress isn’t able to provide President Obama with a Tax Act by the end of the year:

  • The 10% tax bracket disappears reinstating the 15% rate as the lowest tax rate.
  • The 25% tax rate jumps to 28%.
  • The 28% tax rate jumps to 31%.
  • The 33% tax rate jumps to 36%.
  • And the 35% tax rate jumps to 39.6%.

As you can see, while the lowest rate increases by 5% and the top rate increases by 4.6%, the three other brackets increase by 3% each. Since the 10% bracket is quite small, and the top bracket only affects taxpayers earning more than $400k, most people should see their federal income tax burden increase by about 3% of their taxable income assuming Congress lets the current tax rules expire. For each $100k of taxable income, therefore, expect to pay $3k more in federal income taxes.

The Pre-2011 AMT

Ever since the 2001 Tax Act was enacted, the Alternative Minimum Tax (AMT) increased the federal tax burden for many middle-income and high-income taxpayers. Remember, each year, you need to calculate your taxes two different ways – the regular way, and then again under the AMT rules. Whichever tax is higher is the tax you pay.

Based on our database of clients, more than half of our married couples who filed joint returns ended up paying the AMT last year. Plus, married couples who paid the AMT paid an amount equal to 2.2% of their taxable income for this secondary tax. For single individuals hit by the AMT, they ended up paying a federal tax premium equal to 1.8% of their taxable income.

The Raw Data

To prepare for this article, I researched the AMT paid by my firm’s individual tax clients per their 2009 federal income tax returns. Here is what I learned:

Married Couples:

Due to a variety of factors, the AMT affects the majority of tax returns prepared for my firm’s married clients.

  • Out of the 1,489 tax returns my office prepared for married couples filing jointly, 847 of those clients, or 57%, were hit by the AMT.
  • All but a few of our married clients whose Adjusted Gross Income (AGI) fell between $210k and $615k paid the AMT.
  • If a couple paid the AMT, the AMT exceeded their regular tax calculation by an average of 2.2% of their taxable income.
  • Not one married couple with AGI in excess of $1 million paid the AMT.

Check out the scatter graph below showing the AMT paid by all 1,489 of our “Married Filing Joint” clients as compared to their AGI. Notice that there are very few data points showing zero dollars of AMT between $200k and $600k of AGI.

Scatter Chart Comparing AMT with AGI for Married Couples

Single Individuals:

Based on the tax returns prepared by my office, the AMT does not seem to affect Single Taxpayers nearly as much as Married Couples.

  • Out of the 719 tax returns my office prepared for Single individuals, 133 of these clients, or 18.5%, were hit by the AMT.
  • All but a handful of these clients whose AGI fell between $210k and $360k paid the AMT.
  • If a single person paid the AMT, the AMT  exceeded his or her regular tax by 1.8%.

Other Filers

For our other clients, 100% of our Head of Household clients with AGI in excess of $135k and 100% of our Married Filing Separately clients with AGI in excess of $100k paid the AMT.

The Silver Lining

The very unpopular AMT might actually absorb the impact of much of the impending tax hike for many taxpayers. Remember, anyone paying the AMT will not see any increase in their federal tax liability due to the 3% rate increase until their AMT liability is fully erased. Since our database of clients showed that married couples hit by the AMT are already paying on average a tax premium of 2.2% of their taxable income, they should see their tax burden increase by less than 1% of their taxable income. Single individuals, due to the fact that affected taxpayers paid an average of 1.8% of their taxable income in additional AMT, should still only feel a 1.2% tax increase on the 3% rate increase.

Plus, reaching the point where middle income taxpayers are no longer hit by the AMT means taxpayers can once again benefit by some good old-fashioned tax planning. We’ll keep an eye on changes that Congress makes to the regular tax rules and to the AMT later this fall to help you figure out how to best plan for the remainder of 2010 as well as for 2011 and beyond.

Or A Dark Cloud

Before crowning the AMT as the savior to middle-income taxpayers, the AMT is currently a dark cloud over everyone’s 2010 taxes. Just as in prior years, Congress has not yet passed an extension to the AMT rules that minimize its impact for millions of middle-income taxpayers. The last time this was a potentially huge issue was back in 2007, and Congress wasn’t able to pass their annual AMT relief until December 19th of that year. Had Congress not acted, the number of taxpayers paying this tax was expected to jump six-fold – from 4 million in 2006 to 23 million in 2007.

Check out these two articles from a few years back to learn about this potential tax mess that could affect millions of taxpayers if Congress isn’t able to once again extend AMT relief through the end of this year.

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