The 15 Percent Rate on Capital Gains: A Casualty of the Alternative Minimum TaxGreg Leiserson The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.
Tax rate reductions on long-term capital gains and qualifying dividends were a key, highly touted component of the tax cuts passed in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). However, like the 2001–2006 tax cuts more broadly, taxpayers affected by the individual alternative minimum tax (AMT) may not pay the advertised lower rates. This article explains the interaction between the capital gains rate and the AMT and provides example tax calculations for two sample taxpayers.
The text below is an excerpt from the complete document. Read the full paper in PDF format.
Tax rate reductions on long-term capital gains and qualifying dividends were a key, and highly touted, component of the tax cuts passed in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). However, like the 2001–2006 tax cuts more broadly, taxpayers affected by the individual alternative minimum tax (AMT) may not pay the advertised lower rates. Even when the AMT is patched so as to prevent it from affecting middle-income taxpayers, as it was in 2006, it can substantially increase the marginal tax rate affecting capital gains and dividends.
The essential interaction creating this rate increase arises because capital gains are included in alternative minimum taxable income (AMTI), and can therefore reduce the taxpayer’s AMT exemption, even though the gains are not taxed at AMT rates. When calculating the additional tax owed on the next dollar of capital gains, AMT taxpayers first pay the statutory 15 percent rate on the gain directly. Then, since the increase in AMTI will decrease the value of their AMT exemption, they pay additional tax on the portion of their other income that is no longer sheltered by the AMT exemption. As a result, the actual tax burden on additional realizations is the 15 percent rate on gains plus the applicable AMT rate (26 or 28 percent) multiplied by the exemption phase-out rate (25 percent). Depending on what AMT bracket the taxpayer is in, this interaction increases the effective marginal rate on long-term capital gains and dividends from 15 percent to either 21.5 or 22 percent.
The attached tables illustrate this interaction for two families, one affected by the 26 percent AMT rate and the other by the 28 percent rate.
The complete paper is available in PDF format.
