National Commission on Restructuring the Internal Revenue Service
708 O’Neill House Office Building
Washington, DC 20515

March 26, 1997


Dear Commissioners:


This letter is submitted in response to your solicitation of taxpayer suggestions to improve the functioning of the Internal Revenue Service ("IRS"). Specifically, this letter addresses the Alternative Minimum Tax (the "AMT"). The AMT is illustrative of the many overly complex and burdensome provisions of the tax law that ultimately encourage non-compliance and under-mine confidence in the system of self-assessment. With all of the complications of the law, it is a near certainty that IRS agents dealing with hundreds of taxpayers’ fact patterns may have difficulty ascertaining whether the law has been fully complied with. Elimination of the AMT could decrease significantly both the enforcement and interpretive burden for the IRS and save countless tax-payers many hours of collecting the information necessary in order to pay the tax as well as time spent on tax planning in an effort to minimize its effect on business decisionmaking.


Cause of Complexity

Although attributing the income tax system's ills to the "bureaucratic inefficiency" of the IRS may be politically expedient, it will not offer a completely satisfactory, long-term solution. The truth of the matter is that unnecessarily complex tax legislation often is the root cause of non-compliance and IRS’ inability to function efficiently. Even if it were to function perfectly, the IRS would be hard pressed to administer many of the very complex and burdensome provisions of the tax law. The AMT imposed by Section 55 et seq is a prime example of such a complex law.


Technical Complexity

The AMT is an entirely parallel system of income taxation. It requires taxpayers, who may or may not be subject to it, to perform a dual calculation of taxable income. First, regular income tax liability is calculated using all of the numerous deductions and credits allowable under the income tax. Second, an entirely separate calculation is required for all but the smallest of firms (those with income subject to AMT under $40,000).

For purposes of calculating the AMT, numerous adjustments are made to a taxpayer's income. In fact, at least twenty different adjustments are mandated. These adjustments regard: depreciation of post-1986 property; amortization of certified pollution control facilities; amortization of mining exploration and development costs; amortization of circulation expenditures for personal holding companies; certain gain or loss adjustments; long-term contracts; installment sales; merchant marine capital construction funds; a special deduction for organizations similar to Blue Cross, Blue Shield; tax shelter farm activities; passive activities of closely held corporations and personal service corporations; loss limitations; depletion; tax-exempt interest from specified private activity bonds; charitable contributions; intangible drilling costs; financial institutions' reserves for losses on bad debts; accelerated depreciation of real property prior to 1987; accelerated depreciation of pre-1987 lease personal property by holding companies; and adjusted current earnings.

The last of these numerous adjustments, the adjusted current earnings or "ACE" adjustment, actually entails eight series of adjustments itself. The first series of ACE adjustments is for depreciation, which requires a separate entry for each of seven possible depreciation methods used by a tax-payer. Although this depreciation adjustment was eliminated beginning in 1994, it was done so prospectively. Therefore, the ACE depreciation adjustment must still be made for property placed in service prior to 1994 that is not yet fully depreciated. For most AMT payers, this calculation will, therefore, be required for another 10 to 15 years.

The second series of ACE adjustments encompasses the following items included in earnings and profits ("E&P"): tax-exempt interest income; death benefits from life insurance contracts; all other distributions from life insurance contracts; inside buildup of undistributed income in life insurance contracts; and "other items." The third series of ACE adjust-ments is a disallowance of the following items not deductible from E&P: certain dividends received; dividends paid on certain preferred stock of public utilities that are deductible under Section 247; dividends paid to an ESOP that are deductible under Section 404(k); nonpatronage dividends that are paid and deductible under Section 1382(c); and "other items." The fourth series of ACE adjustments includes those for intangible drilling costs; circulation expenditures; LIFO inventory adjustments; and installment sales. The fifth ACE adjustment is the disallowance of loss on the exchange of debt pools. The sixth ACE adjustment regards acquisition expenses of life insurance companies for qualified foreign contracts, and the seventh ACE adjustment regards depletion expenses. The eighth and final ACE adjustment is a series of basis adjustments for determining the gain or loss from the sale or exchange of pre-1994 property.

As a mere description of these adjustments indicates, calculating the AMT of a taxpayer is no mean feat. In addition to these adjustments, a taxpayer must also calculate a separate "alternative tax net operating loss deduction" (ATNOLD) and a separate alternative minimum tax foreign tax credit. Each of these must be recalculated using the rules provided by the AMT.

Although the sheer complexity of these numerous adjustments is staggering, another difficult and time-consuming challenge for taxpayers is maintaining the detailed records requisite for correctly calculating these adjustments. Each of these adjustments for AMT requires taxpayers to keep multiple sets of records. For depreciation alone, there are at least seven different systems currently in use — each requiring its own set of records.


Relative Complexity

The discussion above makes more than evident the complexity of the AMT. A comparison of the AMT's complexity to other provisions of the tax law underscores this fact and highlights the relatively higher compliance costs imposed by the AMT.


Form 4626 Time Estimates

Perhaps the most eloquent illustration of the AMT's complexity is encapsulated in Form 4626 and the instructions thereto. A copy of Form 4626 is attached for reference. The instructions to Form 4626 indicate that the IRS' estimated average time to complete and file Form 4626 is as follows: 18 hours, 53 minutes for record-keeping; 14 hours, 42 minutes to learn about the law; and 15 hours, 40 minutes to prepare and send the form to the IRS. Setting aside the optimism entailed in the time estimates "calculated" by the IRS, this time is quite significant. As a comparison, the time estimates provided by the IRS for filing a general corporate return, Form 1120, are as follows: 71 hours, 31 minutes for record-keeping; 41 hours, 46 minutes to learn about the law; and 71 hours, 46 minutes to prepare the form. Even by this extremely modest estimation, the total burden exacted by the AMT is at least 26% of that exacted by the corporate income tax.


Corporate Surveys

Corporate tax and accounting executives regard the AMT as one of the most complex, if not the most complex, aspect of the federal income tax. In a survey conducted by Professors Joel Slemrod and Marsha Blumenthal, 325 senior corporate tax executives responded to a survey asking them to indicate the most complex provisions of the Internal Revenue Code. Of the respondents, 22.1% cited the AMT as the most complex. These results placed the AMT at number two on the list — only .5% behind number one (depreciation), but a good 6% ahead of number 3 (the uniform capitalization rules). In a survey conducted by the General Accounting Office, all respondents cited AMT as among the provisions in the Internal Revenue Code with the largest record-keeping and compliance cost burden.


Burden for IRS

If compliance with the AMT is difficult for taxpayers, it can be no less so for revenue agents charged with audit re-spon-si-bility. Although the IRS does not release statistics similar to those contained in surveys on the corporate AMT compliance burden, there can be little doubt that ensuring compliance with the AMT requires a substantial commitment and investment by the IRS in training and education of revenue agents, not to mention the amount of time it takes to perform the audit on AMT in addition to the regular tax calculation.

Assuring the technical competence of the revenue agents who must perform the audit is also no doubt a significant problem for the IRS. Most agents in the large case examination program are well trained professionals who develop specialized skills for dealing with a given industry. The training and education they must master to be prepared to examine the many different and complex fact patterns is essential to the enforcement process. Yet the AMT requires them to understand not one, but two sets of calculations. A quick review of the AMT form indicates that at least 95 different code sections are cross referenced with the AMT. This means the agent must understand how the regular tax code sections work and how the AMT treats each item differently. Requiring this breadth of knowledge almost assures that the IRS faces significant challenges in maintaining a workforce of auditors who fully understand all of the requirements of the tax law. This is especially the case for the many agents who are auditing businesses that are not part of the large case examination program and who may have less training and technical resources available to them.

Another cost that is seldom considered is the tremendous burden on the IRS in interpreting the statute. While three major regulation projects on AMT have been completed, the very significant consolidated AMT regulations have been awaiting final approval since 1993 when they were issued in proposed form. Further, the IRS has had a significant number of requests for letter rulings or other types of guidance. Most of these requests stem from the complicated nature of the statute. Significant resources must be devoted to this area in addition to the more commonly identified area of enforcement.


Compliance Costs

As mentioned above, calculation of the separate adjustments for the AMT is required of all but the smallest businesses. Making the prescribed adjustments and maintaining separate records is very costly to the remaining taxpayers. Over one-third of the respondents in a study of the compliance costs of Fortune 500 companies cited the AMT as contributing most significantly to tax compliance costs. Some estimates place the cost of compliance with the AMT at approximately 17% of a business's overall tax compliance cost.

In this respect, it should be noted that the true compliance cost of the AMT is often drastically understated by those who advocate this alternative system. Although taxpayers may be "subject" to the AMT only in one of several years, this does not significantly reduce the compliance costs for years in which the taxpayer is not "subject" to the AMT. The AMT record-keeping burden is ongoing; a taxpayer must maintain the information needed to comply with the AMT during those years when it is not liable for the AMT. A General Accounting Office study noted that although only 2,000 large corporations accounted for 85% of the AMT payments in 1992, over 400,000 companies had to file Form 4626 and incur the compliance cost. For every firm owing AMT, 14 additional companies were required to perform the record-keeping for and calculation of the AMT. Since most of the adjustments prescribed by the AMT build on prior years' information (e.g., depreciation), AMT compliance is an ongoing cost.

While most of the compliance studies have focused on the burdens placed on large companies, it should not be overlooked that corporations of all sizes must calculate and maintain the requisite records for the AMT. According to IRS statistics, approximately 80% of all AMT returns filed were for companies with less than $10 million in assets and fully one-third had assets of less than $1 million. For many of these firms, the cost of hiring accountants to collect the records needed for AMT and the actual cost of calculating the tax may be significantly more than they owe in tax. For these firms, it is not unreasonable to simply decide to play the "audit lottery" and agree to any proposed adjustment by the IRS should they be selected for audit. This decision is certainly not out of any motivation to evade the tax laws. It is rather a decision on the part of the company that the cost of hiring the outside help necessary to fully understand and interpret this section of the tax law is unwarranted, particularly if the company has never had a positive AMT liability in the past and has no reason to believe they may have an AMT liability now.


Economic Inefficiencies of AMT

The enormous complexity of the AMT has promoted both economic waste and taxpayer non-compliance. Complex tax provisions such as the AMT generate great inefficiency by causing firms to devote substantial resources to comply with them. Compliance costs and the resources devoted to tax planning represent pure deadweight loss to the economy; these expenditures create no real output for society, but simply reduce a firm's tax payments to the government.

Recent studies also indicate that the inefficiencies created by the AMT are not just compliance related. In fact, the AMT has a very negative effect on business investment which has a huge impact on business planning. One study suggests that the AMT reduces investment by as much as 5% due to the increased costs of capital for the AMT payers and the uncertain impact of the tax on investment by firms that are not currently subject to AMT but could easily become subject to AMT in the near future.

Furthermore, there is a huge cost to the general economy. Studies indicated that GDP would increase by as much as 1.6 % if the AMT penalty on investment were removed and that as many as 100,000 jobs per year over a five-year period would be created. These jobs would be concentrated in high-wage industries such as manufacturing, transportation, mining and the other businesses that provide services to these industries. The creation of these high-wage jobs means that companies will grow, and ultimately their profits will increase.

While Congress hoped to take tax considerations out of business planning decisions during the 1986 Tax Reform Act, they actually increased the need for tax planning when making investments. Because the AMT can have a retroactive effect on investment, businesses must consider the possibility that they will be subject to the tax penalty in a later year, thus modifiying the projected rate of return on the investment. Consequently many investments will never go forward due to the uncertain financial impact of AMT.


Revenue Collection and Cost-Savings

The AMT is neither an essential nor an efficient means of revenue collection. From the perspective of the IRS alone, elimination of the AMT makes eminent sense.

By 1992, the gross amount of AMT paid had declined from a high of $8.1 billion in 1990 to $4.9 billion. The net amount raised by the AMT, after considering the AMT credit, was $2.6 billion in 1992. This represents only 2.7% of the total regular income tax revenue from corporations of $96.0 billion in 1992.

As evident from the preceding discussion, the AMT is an extremely complex and costly way to collect taxes. In fact, it is about the least efficient way of raising revenue that one could think of, given the extraordinarily large amount of resources devoted to AMT by both the IRS and taxpayers.

We urge the Commission to seriously consider recommending to Congress that the AMT be eliminated in an effort to reduce the burden on the collection and enforcement systems of the IRS as well as the compliance burden of all businesses, both large and small.


Very truly yours,


Gil Thurm
Vice President
Taxation and Economic Policy
National Association of Manufacturers
1331 Pennsylvania Avenue, NW
Suite 1500 - North Tower
Washington, DC 20004-1790
(202) 637-3075