Charitable Deductions, Alternative Minimum Tax, and Health Insurance welfare

by philg

I met with my accountant last week. I learned the following:

  • advertised marginal tax rates should be ignored by upper middle class taxpayers; the alternative minimum tax (AMT) is the real tax rate and it is substantially higher. Even in a state with an average income tax rate, such as Massachusetts (5.3% on most income), taking a deduction for state tax paid will trigger the alternative minimum tax
  • contributions to charity have very little effect on the total tax paid by someone subject to alternative minimum tax; a charitable deduction lowers one’s standard tax, but does not lower one’s AMT. The IRS forces you to pay the AMT if it is higher. So… give to charity if you feel as virtuous as Elvis Presley, who never took a deduction because it “took away from the spirit of the gift”, but don’t expect it to lower your tax bill.
  • we do indeed live in a nearly perfect welfare state for health insurers. A self-employed person who pays $5000 for health insurance can deduct part of that. A self-employed person who pays $5000 directly to doctors and hospitals cannot deduct any of that (except the part that exceeds 7.5 percent of income).
  • the costs of complying with the Massachusetts requirement to purchase health insurance are substantial; the state had no idea how many people were uninsured so they are using the tax system to figure it out. The accountant calls customers to obtain their proof of insurance certificates. The customers call their insurance companies to obtain these documents in hardcopy. Then they have to be re-mailed. Then someone at the accounting firm has to open the mail, put the document in the correct file and inform the accountant to stop nagging the client. These costs imposed on taxpayers are in addition to the billions of dollars in direct costs for additional policies purchased and for state subsidies to insurance companies for customers who aren’t wealthy enough to afford what are now the nation’s highest cost policies. (more: see my health care reform plan)

The tax code is becoming ever more complex. If you buy business equipment, for example, you have to calculate depreciation both for regular tax and for AMT. This calculation is done every years for 5 to 10 years. If you rent out an apartment, you pay tax on any income. If you lose money, though, you can’t deduct the loss. You are supposed to accumulate any loss years and subtract the total from whatever you get when you sell the apartment, so the operating loss turns into a reduction in capital gain. (Unless you’re a Congressman in charge of the committee that makes tax laws for commoners; in that case you don’t pay tax on your rental income and you don’t pay market rent on the four apartments that you occupy in Manhattan (see Charles Rangel)).

My taxes are pretty simple because I don’t trade individual stocks. All of my investments are in mutual funds. I do have some self-employment income and I rent out an apartment that I own. The number of pages of filled-out forms and schedules, for both state and federal taxes, that the accountant sent me for review is 124.

6 thoughts on “Charitable Deductions, Alternative Minimum Tax, and Health Insurance welfare”

  2. Even more fun is you can’t deduct health insurance payments if unemployed. For the self employed California is pulling even more stunts such as requiring accelerated payment of various taxes, paying various registration fees early and a whole bunch of similar unsustainable tricks my CPA told me about.

    The tax code in this country is beyond absurd. I really don’t understand why people tolerate it. I am still astonished that I have to pay someone to do my taxes because of their complexity.

    If I was Obama I’d be directing the IRS to reduce the size of the tax code in half each year. (Yes it is ultimately congress’ fault.)

  3. Jeff: 2/3rds of the diamond trade is done under-the-table. This is possible because diamonds and money can be anonomyous.

    Such is more difficult to accomplish with the identities of those involved in stock trades and other forms of abstracted capital management.

    Would it be costlier to pay the taxes or to militarize the trading outfits in-order to protect the identities of the fund investors from any interference or discovery?

  4. Ah, the AMT. Essentially Congress of 1969 admitting that they thought the tax code was broken because rich people kept using deductions Congress wrote into law, but instead of fixing the tax code Congress created a separate tax system. And each Congress since then hasn’t been willing to give up the extra money.

  5. The complexity of the tax code is merely one very visible symptom of a broken and entirely corrupt campaign finance “system” that is the root cause of much of what is wrong with this country. The tax code is Congress’ favored mechanism for delivering what campaign donors buy. As Congress makes those deliveries, they get added to the tax code and the complexity accumulates. The donors get the breaks they bought, and everyone else gets a nightmare of navigating confusing and possibly conflicting rules and requirements. And a “parasitic” industry of accountants and tax preparation companies arises to help wealthy individuals and corporations take advantage of the breaks and handouts intended for donors, while also profiting from ordinary folks who get no breaks or handouts but only complexity and confusion.

    The AMT is probably the most broken and corrupt part of the tax system. Although it was meant to patch an unfairness in the tax code that let a few very wealthy individuals avoid taxes, it now creates a much larger unfairness. There are now many more of the wealthy people AMT was meant to tax, but their accountants have found ways to wiggle out of the AMT. Instead, a large and continually increasing number of people who were never intended as targets get ensnared in the AMT. They not only have to pay additional tax, but they have to compute their taxes twice. The worst part is that the shell game Congress plays with the federal budget relies on the revenue the AMT brings in from all those people to whom it was never meant to apply. So the politicians can make cosmetic tweaks and score points by acknowledging the unfairness, but they dare not actually fix the problem.

    Yes, it’s needlessly complex and unfair. But a tax code that grows increasingly complex and unfair with each session of Congress is an inevitable consequence of our “one dollar one vote” political system. Reform campaign finance and you fix not only an inequitable tax code but many other problems (such as health care, which is broken for the very same reason). Unfortunately, I think true campaign finance reform that makes politicians accountable to the people rather than donors will have to await the arrival of Messiah.

  6. Ted, just how is it that accountants to the wealthy have figured out how to wiggle out of AMT? I’d sure like to know.

Comments are closed.