Treasury Sides with Senate in AMT Standoff

The Treasury has weighed in on the side of the U.S. Senate in a standoff with the House of Representatives over how to prevent the Alternative Minimum Tax from spreading to millions of new taxpayers this year.

AP

"I thank the Senate for passing a bill that prevents 21 million Americans from paying the Alternative Minimum Tax this year and that does not raise other taxes," Treasury Secretary Henry Paulson said in a statement this morning.

The one-year "patch" was passed by the Senate last night on an 88 to 5 vote after Democrats gave up on their effort to offset the $51 bilion loss in federal revenue with increases in other taxes.

House Democrats are now planning to send another version of the AMT patch to the Senate, with revised revenue offsets they hope can attract the 60 votes needed to overcome a Republican filibuster.

The major bone of contention between the two parties is a provision raising taxes on private equity and hedge fund managers.

The AMT is a parallel income tax that was originally designed in the late 1960s to prevent a few hundred very high earners from avoiding taxes. However, because it was not indexed for inflation it now affects increasing numbers of middle class taxpayers.

Senate's One-Year Fix

The Senate bill provides a one-year fix for the alternative minimum tax but without matching the cost of the tax relief with new tax revenue. Without the fix, an estimated 25 million people would be subject to the higher AMT tax, up from 4 million in 2006.

The Senate vote puts it at odds with the House, where Democratic leaders, under a principle of not adding to the national debt, demanded that the AMT fix be paid for. Last month, the House passed legislation matching the AMT fix and other tax cuts with about $80 billion in new tax revenues.

Senate Finance Committee Chairman Max Baucus, D-Mont., said it was not his first choice to pass an unpaid-for bill but "this is our best choice." He said 12 million people in the $100,000 to $200,000 income level alone would be hit by the AMT without the fix, and "we need to stop that from happening."

The bill now goes back to the House, where Rep. Charles Rangel, D-N.Y., chairman of the tax-writing Ways and Means Committee, suggested making up the difference by closing a loophole on offshore funds that now escape taxation.

Senate Majority Leader Harry Reid, D-Nev., said after the vote that he had heard the House would accept the Senate version. But Rangel said the House would "give the Senate another chance to do the right thing and pass responsible AMT relief."

The White House, in a statement, praised the Senate action. "We encourage the House of Representatives to swiftly pass this bill to stop this tax increase and to prevent a costly delay in refunds."

Earlier Thursday, Senate Republicans united in stopping the Senate from moving to the House-passed bill. The vote was 48-46 against beginning debate on the House bill, 14 short of the 60 needed.

The Finance Committee's top Republican, Charles Grassley of Iowa, said it was time for Democrats to abandon their "PayGo obsession," referring to the "pay-as-you-go" principle that tax cuts or spending increases should be paid for so as not to add to the federal deficit. With the "clean" AMT bill, "the Senate Democratic leadership seems to realize that the AMT should not be offset," he said.

House Democratic leaders throughout the day Thursday reaffirmed their commitment to PayGo.

Republicans, said House Majority Leader Steny Hoyer, "complain that we pay for this legislation by closing tax loopholes. Their solution? Just add the costs of the AMT fix ($50 billion) to the deficit and national debt. I absolutely reject this fiscally irresponsible approach."

May Have to Postpone Return Processing

Without congressional action, the IRS, unsure of the final status of the tax, says it may have to postpone the processing of returns scheduled to begin in mid-January. That could mean delays for millions of people waiting for income tax refunds worth billions of dollars. The tax agency says it will take about seven weeks after the tax is revised to reprogram and test forms reflecting the changes.

For weeks, Democrats and Republicans have blamed the intransigence of the other party for the delay. "The Democrats' unprecedented and indefensible delay on this commonsense solution means the filing season will already be disrupted," Senate Republican leader Mitch McConnell, R-Ky., said.

"They find it offensive to have to pay for these tax cuts," Reid said of Republicans. "This is a $50 billion patch. Shouldn't it be paid for? The answer is obviously 'yes.'"

The AMT was created in 1969 to ensure that a small number of wealthy people could not use tax breaks or deductions to eliminate their entire tax bill. But the tax was not indexed to inflation, and every year more people are exposed to it. Nearly 4 million taxpayers were subject to this tax in 2006, and the number is expected to multiply in 2007.

Baucus likened the AMT to Frankenstein, saying that "unless we act it will destroy the entire tax system."

Congress has reacted by passing annual fixes to prevent the number of people subjected to the AMT from growing.

This year, however, the first with Congress under Democratic control, that fix has been blocked by a fundamental difference between the two parties over whether to find ways to pay for revenues lost from the anticipated expansion of the AMT.

House Democrats, committed to offsetting any lost revenues, passed a bill that included $80 billion in new tax revenues, $50 billion for the one-year AMT patch and $30 billion to extend several dozen tax credits about to expire.

Baucus has proposed a compromise under which there would be no offset for the AMT but there would be new taxes to fund a two-year extension of the tax credits.

The "Blue Dogs," a coalition of 47 fiscally conservative House Democrats, issued a statement Tuesday urging Democrats to hold their ground. "We made a commitment to the American people to reinstitute 'PayGo' budget rules and restore fiscal responsibility to government, and we will stand by that commitment."

House Speaker Nancy Pelosi said Thursday she fully supported that position.

The Senate bill leaves for later consideration what to do about the several dozen targeted tax breaks. The House bill would expand the child tax credit, providing a property tax deduction to some 30 million families, extend a tax exemption for the combat pay of military personnel and extend tax breaks for teachers and research and development.

© 2009 CNBC