ALTERNATIVE MINIMUM TAXPAYERS: WHO THEY ARE AND WHERE THEY LIVE

National Tax Association

ALTERNATIVE MINIMUM TAXPAYERS: WHO THEY ARE AND WHERE THEY LIVEAuthor(s): Charles L. Ballard and Paul L. MenchikSource: Proceedings. Annual Conference on Taxation and Minutes of the Annual Meeting ofthe National Tax Association, Vol. 98 (2005), pp. 264-272Published by: National Tax AssociationStable URL: http://www.jstor.org/stable/41954910 .

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ALTERNATIVE MINIMUM TAXPAYERS: WHO THEY ARE AND WHERE THEY LIVE

Charles L. Ballard and Paul L. Menchik, Michigan State University*

INTRODUCTION

The federal is a

federal tax

individual structure

alternative parallel income

minimum to tax. the tax

When regular (amt)

a is a tax structure parallel to the regular federal individual income tax. When a

taxpayer's regular federal tax liability is calculated to be "too low," as a result of personal exemptions, certain deductions, operating losses, and other items, additional tax liabilities are triggered under the AMT. The AMT was originally designed to prevent a very small number of wealthy taxpayers from avoiding paying any income tax. However, due to non-indexation of the AMT exemptions, rate reductions in the regular federal income tax, and the scheduled termination of temporary increases in the AMT exemption, the AMT is expected to become rapidly more important for middle- and upper-middle income taxpayers in the coming years. If the law is not changed, the number and proportion of AMT filers will increase dramatically over time. 1 In addition to the financial cost of filing the AMT, there may also be a very substantial time cost for some taxpayers.

In this paper, we use micro data from the Sta- tistics of Income Division of the Internal Revenue Service for 2001 , to determine the way in which the AMT is distributed across the income spectrum. We also look at the state of residence of taxpayers who pay the AMT, and the geographical distribution of the amounts paid.

This paper is part of a larger research effort. Previously, we considered the degree of exporting of state and local taxes, due to federal deductibility (see Ballard and Menchik, 2005). In that earlier analysis, we did not take into account the effects of the AMT. However, the AMT has the potential to modify those results. Thus, this paper stems from our prior research.

*This paper is a revised version of a paper presented at the 2005 Annual Meetings of the National Tax Association, in Miami, Florida. We are deeply indebted to the Statistics of Income Division of the Internal Revenue Service for providing us with data, to the Department of Economics at Michigan State University for paying for it, and to our stalwart research assistants, Adam Cogswell and Michael Gallagher, for their tireless efforts. We are also grateful for helpful comments from Janet McCubbin and Jeffrey Wooldridge.

DATA AND METHODOLOGY Our primary data resource is the 2001 Public

Use Tax File, assembled by the Statistics of Income Division of the Internal Revenue Service (see U.S. Department of the Treasury, 2004). This data set, which contains 143,221 tax records, is a probability sample of federal individual income tax returns for 2001. It contains a wealth of information from tax returns, while assiduously protecting taxpayer confidentiality. One of the ways in which the sample protects confidentiality is to mask the state of residence of high-income taxpayers. Spe- cifically, the state code is removed from the data set for taxpayers with adjusted gross income above $200,000, and the entry for state and local income tax is "blurred" for these taxpayers.

Our research is complicated significantly by the masking of state of residence, since a large number of AMT taxpayers have income over $200,000. We employ a statistical strategy to predict AMT payments by state for this important part of the population. Using the SOI micro data, we estimate the fraction of income that is devoted to AMT payments for those with income over $200,000, as a function of the taxpayer's characteristics. (Since the percentage of income devoted to AMT payments is constrained at zero, we employ Tobit analysis.) We then refer to published data from the Statistics of Income Web site to get mean values for the explanatory variables used in the Tobit regressions, by state and by income category.2 Finally, we take the estimated coefficients, and use the mean values of the regressors to predict what the AMT payments would be, for the income categories for which state of residence is masked.

Based on the tax rules and other research, one would expect AMT obligations to be related to state-and-local income taxes and property taxes, as well as to the number of exemptions and other covariates. Also, since the AMT has an exemption, adjusted gross income (AGI) should be quite important in determining AMT liability.3 Our Tobit regressions reveal that these and other variables do indeed have significant effects on AMT liabilities. Detailed results from the Tobit regressions are available on request.

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98™ ANNUAL CONFERENCE ON TAXATION

THE DISTRIBUTION OF AMT PAYERS AND PAYMENTS FOR THE UNITED STATES

In Table 1 , we show the number of AMT payers and the amounts paid, for various categories of AGI. Note first the surprising result that some taxpayers with negative income pay the AMT. This is because the tax base for the AMT is not adjusted gross income. The AMT requires deferral of net operating losses; hence we see positive AMT obligations in the lower (and negative) income categories.4

As shown in Table 1, 1.12 million taxpayers had total AMT obligations of about $6.14 billion in 2001 . The number of taxpayers paying the AMT ranged from only 353 in the 0-to-$ 10,000 AGI category, to 352,000 in the $200,000-to-$500,000 category. The proportion of those in a given income category paying the AMT ranges from ap- proximately zero to more than one out of six in the $200,000-to-$500,000 income category. The total dollar amount of AMT obligation by AGI category ranges from about $2.6 million (in the $20,000- to-$30,000 group) to about $2.36 billion (in the $200,000-to-$500,000 group). The mean dollar amounts of AMT paid by AMT payers in each AGI category are presented in the sixth column of Table 1 . These are followed in the seventh column by the mean dollar amounts of AMT payments for all taxpayers in each AGI category (including those who did not have any AMT liability). This last column conveys the average financial burden of paying the AMT, for the members of each income category. Of course, these numbers may underestimate the true economic cost of the AMT, since they do not include the time and money costs of compliance. Moreover, we do not attempt to estimate the excess burdens that may occur when taxpayers alter their behaviors in an effort to avoid the AMT.

In Table 2, we present the distribution of AMT payments and total income tax payments by income category. In the fourth column of Table 2, we show AMT payments as a percentage of AGI. These numbers are comparable to the "average" or "effective" tax rates, in studies of tax incidence by income class. After the surprisingly large AMT obligation among the negative income recipients, the AMT accounts for a very small percentage of income in the lowest positive income categories, and then rises to around one-third to two-fifths of 1 percent of income in the top three income categories. For the population as a whole, AMT payments are about one-ninth of 1 percent of AGI.

Taxpayers in the highest income categories account for a disproportionately large share of the total AMT payments. For example, taxpayers with AGI of more than $200,000 account for 2 percent of the population, and receive about 22.5 percent of all income, but they make 75 percent of the AMT payments! For comparison, we also present the federal income tax obligation (inclusive of AMT) by income category, in the sixth column of Table 2. In the next column, we show the total federal income tax obligations as a percentage of AGI. The income tax is clearly progressive: the percent of income paid in income tax increases monotonically with income, with the highest income group paying 29.5 percent of their income in federal income tax payments. However, while the highest-income 2 percent of the population pay 41.5 percent of the income tax, they pay 75 percent of the AMT. Thus, the AMT is far more progressive than the overall income tax.

In the final column of Table 2, we show the ratio of the shares of income paid in AMT and in total federal income tax, for each income category. The ratio rises sharply, reaching a peak in the $200,000- to-$500,000 category, before subsiding somewhat in the top two income categories.

Of course, the strong progressivity of the AMT depends on the details of current policy. The AMT is now the subject of an ongoing policy debate. Several economists have suggested that the AMT exemption should be kept at its current level, and then indexed. If this were to happen, the AMT would most likely remain a very strongly progressive element of the tax system. However, if the AMT exemption is not increased or indexed, the AMT will almost certainly become significantly less progressive in the future.

THE GEOGRAPHICAL DISTRIBUTION OF AMT PAYERS AND PAYMENTS

Table 3 presents the location of AMT payers by state (including the District of Columbia, as well as a catchall category of Americans residing in Puerto Rico, the Virgin Islands, or Guam, and U.S. citizens abroad). This table is based on the SOI Public Use Sample, for the taxpayers whose state of residence is unmasked. This table excludes taxpayers with AGI of more than $200,000 since the SOI has masked the residence of those taxpayers. As can be seen from the table, these AMT payers are highly concentrated geographically; nearly 40 percent

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Table 3 State of Residence of Alternative Minimum Taxpayers with Adjusted Gross Income

Below $200,000 for 2001* Percent of Percent of Percent of

State AMT Taxpayers AMT Paid Income Tax Paid Alabama 0.36 0.34 1.18 Alaska 0.29 0.35 0.29 Arizona 1.25 1.08 1.61 Arkansas 0.36 0.34 0.63 California 20.83 22.32 12.09 Colorado 0.99 0.80 1.82 Connecticut 1.55 3.29 1.67 Delaware 0.19 0.13 0.33 District of Columbia 0.56 0.32 0.24 Florida 3.92 3.50 5.33 Georgia 1.60 1.96 2.67 Hawaii 0.84 0.43 0.41 Idaho 0.09 0.15 0.33 Illinois 3.14 4.21 4.90 Indiana 0.89 0.50 2.07 Iowa 0.36 1.14 0.91 Kansas 0.65 0.37 0.90 Kentucky 0.48 0.32 1.11 Louisiana 0.51 0.58 1.15 Maine 0.19 0.15 0.39 Maryland 3.46 3.17 2.36 Massachusetts 2.97 2.68 3.06 Michigan 1.72 2.00 3.78 Minnesota 2.66 3.02 1.98 Mississippi 0.17 0.37 0.60 Missouri 1.59 3.19 1.80 Montana 0.01 0.01 0.23 Nebraska 0.42 0.88 0.53 Nevada 0.23 0.10 0.74 New Hampshire 0.54 0.18 0.59 New Jersey 6.14 3.85 4.03 New Mexico 0.17 0.11 0.54 New York 18.45 15.89 6.92 North Carolina 1.65 2.41 2.50 North Dakota 0.02 0.01 0.19 Ohio 3.34 2.99 3.97 Oklahoma 0.06 0.15 0.90 Oregon 1.54 1.73 1.10 Pennsylvania 2.68 2.23 4.41 Rhode Island 0.54 0.24 0.40 South Carolina 0.84 1.59 1.10 South Dakota 0.01 0.01 0.21 Tennessee 0.78 0.65 1.71 Texas 3.86 3.62 6.97 Utah 0.27 0.14 0.57 Vermont 0.06 0.09 0.22 Virginia 2.30 2.51 3.03 Washington 1.09 1.50 2.44 West Virginia 0.06 0.03 0.45 Wisconsin 0.94 0.71 1.95 Wyoming 0.12 0.37 0.12 PR & VI & Abroad 2.23 1.02 0.50 *Note: This table is based only on the cases in which place of residence is disclosed in the data. Some 99 percent of the "masked" cases are ones in which income exceeds $200,000. Source: Authors' computations from the 2001 Statistics of Income Public Use Tax File, and data from the Internal Revenue Service Web site.

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reside in California and New York. On the other hand, the two other most populous states, Florida and Texas, account for fewer than 8 percent of these AMT payers.

While the second column of Table 3 shows the distribution of AMT payers , the third column presents the distribution by state of the AMT payments in the unmasked cases. Once again, California and New York are outliers; over 38 percent of the AMT payments are made by residents of those two states. It is interesting to note that the residents of Connecticut and Maryland contribute nearly as much in AMT payments as the residents of the much larger states of Texas and Florida. These differences among the states are driven primarily by the presence or absence of deductible state income taxes.

In an earlier paper, we studied the geographical distribution of the tax exporting that occurs as a result of federal deductibility of state-and-local taxes (see Ballard and Menchik, 2005). We found that the states are able to engage in substantially more exporting of their taxes if they have larger and/or more progressive income taxes. However, these very same taxes increase the probability of paying the AMT, since they reduce the taxpayer's liabilities under the regular federal income tax. Thus, the states that engage in a high degree of tax exporting also suffer a high degree of AMT incidence. This effectively reduces the amount of tax exporting.

In the last column of Table 3, we present the percentage of the total amount of 2001 federal income taxes paid by the residents of each state.

Table 4 Estimated Payments of Alternative Minimum Tax

By Taxpayers with Incomes over $200,000, for 2001 Over $200K Under $200K Over $200K Under $200K Percent of Percent of Percent of Percent of

State AMT paid AMT Paid State AMT paid AMT Paid Alabama 0.75 0.34 Montana 0.15 0.01 Alaska 0.14 0.35 Nebraska 0.36 0.88 Arizona 1.11 1.08 Nevada 0.80 0.10 Arkansas 0.42 0.34 New Hampshire 0.49 0.18 California 17.92 22.32 New Jersey 5.41 3.85 Colorado 1.65 0.80 New Mexico 0.49 0.11 Connecticut 2.64 3.29 New York 9.25 15.89 Delaware 0.24 0.13 North Carolina 1.80 2.41 District of Columbia 0.38 0.32 North Dakota 0.12 0.01 Florida 6.18 3.50 Ohio 2.74 2.99 Georgia 2.62 1.96 Oklahoma 0.59 0.15 Hawaii 0.23 0.43 Oregon 0.95 1.73 Idaho 0.24 0.15 Pennsylvania 3.67 2.23 Illinois 5.07 4.21 Rhode Island 0.35 0.24 Indiana 1.32 0.50 South Carolina 0.79 1.59 Iowa 0.49 1.14 South Dakota 0.12 0.01 Kansas 0.64 0.37 Tennessee 1.14 0.65 Kentucky 0.72 0.32 Texas 6.06 3.62 Louisiana 0.70 0.58 Utah 0.39 0.14 Maine 0.28 0.15 Vermont 0.16 0.09 Maryland 2.24 3.17 Virginia 3.12 2.51 Massachusetts 4.60 2.68 Washington 1.81 1.50 Michigan 2.70 2.00 West Virginia 0.25 0.03 Minnesota 1.85 3.02 Wisconsin 1.11 0.71 Mississippi 0.38 0.37 Wyoming 0.14 0.37 Missouri 1.13 3.19 PR & VI & Abroad 0.96 1.02 *Note: This table is based on statistical estimates of AMT obligations, using a Tobit model of the share of income devoted to AMT payments as a function of taxpayer characteristics, income, and expenses as revealed in the tax file. Source: Authors' computations from the 2001 Statistics of Income Public Use Tax File, and data from the Internal Revenue Service Web site.

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(Once again, these numbers are only for those with adjusted gross income less than $200,000.) One way of examining the relative importance of the AMT for each state is to compare the last two columns of the table. States whose residents pay a larger share of AMT than income tax are treated relatively disadvantageously by the AMT, while states whose residents pay a smaller share of AMT than income tax are treated relatively favorably by the AMT. The two states that are the largest positive outliers (pay a larger proportion of the AMT than of the income tax) are California and New York, while Texas, Pennsylvania, and Florida lead the states that pay a greater proportion of income tax than of AMT. This is not surprising, since Cali- fornia and New York have large and progressive state income taxes, while Florida and Texas do not have a state income tax, and Pennsylvania has a flat-rate income tax.

The foregoing analysis only focuses on the portion of the tax record data for which place of residence is unmasked. Since so much of the AMT is paid by taxpayers whose state of residence is masked by the 1RS, we use statistical means in an attempt to decipher the location of these high-income AMT payers. For taxpayers whose income is over $200,000, we estimate an equation in which the dependent variable is the percent of AGI devoted to AMT payments. On the right-hand side of the equation are a set of variables that are

both (1) available in the SOI tax-record file, and (2) available in grouped form (by state and income category) on the SOI Web site, as well as transforms of these variables.5 We used the maximum-likelihood Tobit procedure and the ystar prediction command in the STATA package, to get estimates of the share of income devoted to AMT payments, for each of the top three income categories in each state.6

Table 4 presents our estimates of the share of AMT payments made by taxpayers with AGI above $200,000 by state. We find that California and New York still lead the pack, but not by as much as among the under-$200,000 categories. Some of the larger states in which the under-$200,000 taxpayers contribute a modest share of AMT payments (e.g., Rorida and Texas) are estimated to have their over-$200,000 taxpayers contributing a somewhat larger share of AMT payments.

When we commenced our research on the Alternative Minimum Tax, we expected to find that many AMT payers paid a very small amount of tax. In other words, we expected to find that the distribution of AMT payments had a "fat lower tail." This finding would seriously undermine the virtue of the tax, since it would mean that a large number of taxpayers suffer the compliance costs of the AMT, while contributing little to the federal Treasury. Hence, we expected to say something like "25 percent of AMT payers pay less to the Treasury than the value of the time they devote to

Table 5 AMT Payments By Taxpayers in Selected Ranges of AMT Payment for 2001

No. Of AMT Payments By AMT AMT Payment AMT Payment Payers In Range Payers In This Range Range (in dollars) Range Code (in thousands) (in $millions) 1 to 50 1 25.3 0.7 51 to 100 2 27.5 2.0 101 to 200 3 53.3 8.0 201 to 300 4 45.5 11.2 301 to 400 5 46.1 15.8 401 to 500 6 44.5 19.8 501 to 1000 7 175.8 127.7 1001 to 2000 8 193.1 282.9 2001 to 5000 9 254.4 827.5 5001 to 10,000 10 136.5 951.6 10,001 to 20,000 11 66.6 926.6 20,001 to 50,000 12 34.5 1040.9 50,001 to 100,000 13 9.9 693.1 100,001 to 200,000 14 4.2 559.7 200,001 to 500,000 15 2.3 659.0 500,001 to 1,000,000 16 0.5 446.0 1,000,000 & up 17 0.2 355.0

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Figure 1: Total AMT Payments By Taxpayers in Selected Ranges of AMT Payment for 2001

complying with the tax." However, this conjecture turns out to be incorrect. Only 9.4 percent of AMT taxpayers pay $200 or less. If the average cost of complying with the AMT is, say, $200, then we could say (roughly) that fewer than 10 percent of AMT taxpayers pay less to the Treasury than the value of the time they devote to complying with the tax.7

However, even though a relatively small proportion of AMT payers have very small AMT liabilities, it does not follow that the relative size of compliance costs and tax revenues is an unimportant issue. The revenue yield from the AMT only starts to become significant in the aggregate among those with AMT payments of $500 or more. In Table 5, we show the distribution of the number of AMT payers and payments, for different sizes of AMT payment. Figure 1 is based on the data in Table 5. 8 Table 5 and Figure 1 reveal that if the AMT rules could be rewritten to exempt those who pay less than $500, there would only be a small revenue loss of $57 million, in exchange for compliance relief for 242,200 taxpayers. The average amount of AMT paid by these taxpayers is only $237. Thus, for example, if the average compliance cost is $200 per taxpayer, the compliance costs for those taxpayers would amount to over 84 percent of the revenue raised.

CONCLUSION In this paper, we have studied the distributional

effects of the individual Alternative Minimum Tax,

both by income class and by state of residence. We have considered the distribution of the number of payers of the AMT, as well as the distribution of payments. For those with adjusted gross income of less than $200,000, our task has been relatively straightforward. However, for those with AGI of more than $200,000, the state of residence is masked in the Statistics of Income data. For this group of high-income taxpayers, we have employed statistical techniques to infer the distribution of AMT payers and payments by state of residence.

In 2001, AMT payments were made by about 1 . 1 million U.S. taxpayers, or about 0.86 percent of all taxpayers. The total amount of AMT payments was over $6 billion. Thus, the overall revenue yield of the AMT is very small in comparison with the regular federal individual income tax. However, the AMT can be very important for certain taxpayers.

We find that some taxpayers with negative adjusted gross income actually pay the Alterna- tive Minimum Tax. This is because the AMT is calculated on the basis of an income definition that is broader than adjusted gross income. Neverthe- less, we also find that AMT payments are highly concentrated among those with high incomes. In fact, the AMT is substantially more progressive than the regular federal individual income tax, even though the regular tax is also progressive.

The number of AMT payers and the amount of AMT payments are highly concentrated geographically. Among taxpayers with incomes less than $200,000, nearly 40 percent of the payments are

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made by residents of California and New York. This is largely because these are states with large and progressive state income taxes. When these state taxes are deducted from federal income tax returns, the resulting reduction in federal income tax payments can trigger AMT liabilities. Our calculations suggest that AMT payments by those with incomes greater than $200,000 are also concentrated geographically, although not to the same extent as for those with incomes below $200,000.

One final point should be made concerning tax exporting and the AMT. Many tax reformers have advocated the elimination of the AMT. Many tax reformers have also called for broadening the base of the regular federal income tax, by disallowing the federal deductions for state and local taxes (for example, see President's Advisory Panel on Federal Tax Reform , 2005). However, given the realities of political economy, it strikes us that it will be a very difficult task to eliminate deductibility.9 Our work on tax exporting and AMT reveals that the very states whose residents gain from state-and-local tax exporting are the ones whose residents lose from the AMT. In short, the regular income tax "subsidizes" high-tax states, but the AMT takes back part of the subsidy. The presence of two partially offsetting distortions is clearly not a "first-best" policy. (In fact, in this area, as in so many other areas, tax policy seems to be "nth best," where n is rather large.) Nevertheless, the following reform strategy presents itself: if elimination of the deductibility of state-and-local taxes is politically unattainable, it may be better to retain the AMT. This would be an indirect way of reducing the amount of tax exporting. If the AMT is retained, however, we believe a strong case can be made for expanding the exemption and index- ing it (as should have been done originally). This would help to preserve the progressive character of the AMT.

Notes 1 By 2010, the AMT would apply to nearly 30 million taxpayers, and raise $100 billion. (See Burman and Weiner (2005).) 2 We use SOI data for all but one of the taxpayer characteristics used in the analysis. However, the number of exemptions for each filing unit is not available from the grouped SOI data. Therefore, we estimate the number of exemptions by using data on household size from

the Census Public Use Micro Sample (PUMS) data, disaggregated by state and by income category. 3 Currently, the AMT exemption is $58,000 for a mar- ried couple filing jointly, and $44,275 for a single individual. (These amounts are scheduled to fall to $45,000 and $33,750 for the 2006 tax year.) 4 Note, however, that the measure of income used here is annual income, rather than lifetime or permanent income. It is entirely possible that many of the AMT payers with negative AGI are actually very affluent in a lifetime sense.

5 These variables include net business income and its square, farm income and its square, adjusted gross income and its square, state-and-local income tax, real estate tax, medical and dental expenses, dividends, capital gains, charitable contributions, and interest expense. We also include personal exemptions among the explanatory variables, even though personal exemptions are not in the grouped SOI data. We include personal exemptions on the basis of information in the Census Public Use Micro Sample. 6 We are grateful to Jeffrey Wooldridge for helpful comments on the interpretation and use of the Tobit results.

7 However, the foregoing computation does not account for taxpayers who perform the AMT calculations but discover they have no AMT obligation. For these taxpayers, the ratio of compliance costs to AMT payments is undefinably large. 8 Readers should be careful in interpreting Figure 1, since its horizontal axis is not linear. The horizontal axis uses the payment-range codes shown in Table 5.

9 It is hard to see members of Congress from states such as California and New York (of either political party) agreeing to sacrifice a tax provision that is so beneficial to their constituents.

References Ballard, Charles, L. and Paul L. Menchik. Tax Exporting

Through Federal Deductibility of State and Local Taxes. In Proceedings of the 97th Annual Confer- ence on Taxation, Minneapolis. Washington, D.C.: National Tax Association, 2005, pp. 26-38.

Burman, Leonard and Weiner, David. Suppose They Took the AM Out of the AMT? Washington, D.C.: Urban Institute/Brookings Institution, 2005. Discus- sion Paper 25.

President's Advisory Panel on Federal Tax Reform. Sim- ple, Fair, and Pro-Growth: Proposals to Fix America's Tax System. Washington, D.C., 2005.

U.S. Department of the Treasury. Internal Revenue Service. Statistics of Income. 2001 Public Use Tax File. Compiled by Mike Weber, Individual Statistics Branch. Washington, D.C., 2004.

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ALTERNATIVE MINIMUM TAXPAYERS: WHO THEY ARE AND WHERE THEY LIVE