The House Ways and Means Committee estimates that the cost of permanent repeal of the Alternative Minimum Tax (AMT) will be $795 billion over ten years, and while there is widespread agreement that the AMT should be repealed, few in Congress believe that it will be possible to make up for the lost revenue through cuts in spending.

The Committee's proposed legislation, the 2007 Tax Reduction and Reform Act would replace lost AMT revenue with a 4 percentage point replacement tax surcharge on whatever marginal rate a taxpayer is paying when his adjusted gross income (AGI), is above $200,000 ($150,000 for single taxpayers). The surcharge would rise to 4.6 percentage points when AGI is above $500,000 ($250,000 for single taxpayers). All taxpayers at this income level would be affected, not just those with preference items in their income. This proposal is estimated to raise $831.70 billion over 10 years.

Committee Chairman Charles Rangel (D-NY) claims that most taxpayers in these income brackets will pay less with the surtax than under current AMT rules.

Rangel's bill also calls for an increase in the standard deduction of $850 for joint filers and $425 for single filers. He does not expect the bill to be brought to a vote in 2007 and so a temporary AMT "fix" must be enacted soon.

Another provision in the bill that will affect taxpayers with higher incomes would restore limitations on itemized deductions and the phase-out of the deduction for personal exemptions for taxable years beginning after 2007 to the same limitation that existed before the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

The tax increase on the higher incomes does not end with the surtax and limitations on deductions. If Congress doesn't vote to extend the Bush tax cuts that are due to expire in 2010, the top marginal rate goes back to 39.6 percent. Adding the new surcharge would increase the top tax rate to 44.2 percent.

The bill is not popular on Wall Street because it proposes to tax carried interest earned by managers of private equity funds as ordinary income. This would require managers to treat carried interest as "ordinary income received in exchange for the performance of services to the extent that carried interest does not reflect a reasonable return on invested capital," the Bill's summary says. The bill would continue to tax carried interest at capital gain tax rates to the extent that carried interest reflects a reasonable return on invested capital.

Other provisions are specifically directed at hedge funds managers. These managers would be prohibited from using offshore tax haven corporations and other structures to defer taxes on compensation received for providing investment services. In addition, under the bill, "such managers would be required to take this deferred compensation into account as it accrues." Current law generally allows executives and other employees to defer paying tax on compensation until the compensation is paid.

Another hedge fund provision allows pension plans, universities, and other tax-exempt entities to directly invest in hedge funds and other investment funds without incurring unrelated business income tax (UBIT). This would eliminate the current-law incentive for pension plans, universities, and other tax exempt entities to invest in hedge funds and other investment funds through offshore "blocker" corporations formed in tax haven jurisdictions and would improve the investment returns for pension plans, universities, and other tax exempt entities that invest in these investment funds.

The bill extends many current credits including special rules for S corporations making charitable contributions and permits tax free charitable contributions from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per taxable year.

Related stories:

"Carried Interest" in private equity: Capital gain or performance fee?

House and Senate zero in on taxation of fund managers

No repeal of AMT this year - one-year fix proposed

Rangel proposes business tax changes, LIFO repeal

Legislation summary

Text of the legislation