I’m sure that some, or even many of you have heard of the Alternative Minimum Tax (“AMT”). And if you haven’t, then chances are that you will before this year is over. Now, I don’t want to talk about the details of the AMT or bore you with any tax-like analysis that will make your eyes glaze over so don’t worry.

I will however, talk about how a couple of loopholes that pretty much only benefit hedge fund managers is holding hostage a temporary “patch” or fix to the AMT that could have around 20 million more Americans paying more tax than they should. Of course, this is over and above the already millions of people (myself included) who pay this ridiculous tax despite only owning a home and working for “the man”…

I’ll give a bit of background and some detail, but the basic gist of the issue is as follows:

  • The AMT law is screwy and, if not changed, will add thousands in taxes for millions of families even if there is no change to their income situation from last year;
  • Congress is trying to fix this (the House passed a bill within the past week or so) but it will cost over $50 billion to fix, and with the PayGo rules, need/want to offset the savings so as to not add another $50 billion to the deficit;
  • The deficit busting republicans don’t want to pay for the offset and don’t care about adding another $50 billion to the deficit. Of course, this can also allow them to point a finger at Democrats as adding to the deficit as well.
  • A provision that would tax hedge fund managers at the same rates as you and me for services performed in their job as opposed to sweetheart rates that are less than half of the “regular” rates is being used by Bush and the republicans to threaten the entire AMT fix.

So republicans want to help you and me, but don’t want to do it at the expense of their “base” – those who have derived the bulk of the Bush tax cut benefits. Therefore, either another $50 billion (or part thereof) will be added to the deficit (most likely), no AMT fix will be passed at all, screwing another 20 million families (somewhat but not overly likely as this would totally kill republican chances in 2008), or something else will be used to pay for this fix, thereby keeping the sweetheart lower tax rates for hedge fund managers (also possible).

The main republican argument is that this tax (the AMT) never should have hit this many people so therefore a fix shouldn’t need to be paid for because it never was intended to apply here. So with that logic, why do we have to pay for the continued occupation in Iraq, since Rumsfeld never intended for it to last more than a few months?

At issue here is what is called “carried interest”, and deals with certain fees/income that hedge fund managers receive as part of managing the portfolios. Now, in general, income that you get for services, especially in your job, gets taxed at “ordinary tax rates”. This is somewhere around 25% or so, more as you earn more (up to over 35% at the highest levels). Income that you have from investments (i.e., not for performing services for your job) is taxed at a much lower rate of 15%. Somehow, hedge fund managers that get additional income from doing their job are able to say that this is not income from services – that it is services from investing – and that it is taxed at 15%, not (up to) 35%. The additional cost by having these lower rates is around $25 billion over 10 years.

Another tax loophole for these entities/individuals is to defer income to offshore accounts, which ends up comprising around $24 billion over 10 years (same link as above).

Now, this is somewhat of a simple way of explaining this, but know that I am a tax consultant by day who deals with income and employment tax, so I know what income from services is – and these hedge fund managers are receiving it, no matter what they want to try and call it. And my wife works in the tax area as well for private equity and hedge fund clients, so even when she tried to convince me of the rationale, she knew that it was kinda shady at best.

Even articles in The Street and Long Island’s relatively conservative Newsday (I’m from Long Island so trust me on that one…) talk about how this loophole could fix the AMT and help out many millions of Americans.

At this point, we don’t know what the Senate will do. But we do know that Harry Reid is being as strong and resolute as ever about sticking to the PayGo rules and making the minority republicans actually not dictate policy decisions:

In a sharp change in his position, Senate Majority Leader Harry Reid (D-Nev.) signaled Thursday that he is resigned to waiving pay-go rules to offset a one-year patch to the Alternative Minimum Tax (AMT).

But wait, there’s more. In exchange for caving on making a select few pay the same tax rates as everyone else on income they earn from working, Reid will ALSO allow for the extension of expiring tax provisions that Bush and the republicans wanted to extend. At least the republican-desired tax cut extensions is being offset. The problem is that if these cuts get extended, then either other programs get cut or other taxes get increased.

And you can just guess who is and who isn’t going to really be paying for those Bush favored tax cut extensions.