Scenarios Show Winners, Losers
(RIVERWOODS, ILL., November 8, 2005) – Taxpayers who have longed for shorter forms and fewer calculations will get their wish if President Bush and Congress adopt the recommendations of the President’s Advisory Panel on Federal Tax Reform, which were presented to the Secretary of the Treasury on November 1. According to CCH, a Wolters Kluwer business and a leading provider of tax information, software and services, the Advisory Panel’s proposals do indeed simplify many aspects of current tax law, but often at a cost to those who currently benefit from a variety of deductions, credits and incentives. For a CCH Tax Briefing on the Panel and its proposals, go to http://www.cch.com/taxreform.
Although the Panel’s proposals have not yet been formally endorsed by President Bush, they are likely to become a major initiative of his administration, according to Mark Luscombe, CCH principal federal tax analyst.
“The President has indicated that he wants fundamental tax reform, and although the Panel does not junk the income tax altogether, it does address many sources of complexity in the law and proposes a radical reshaping of the current system. I expect that many of the Panel’s ideas will appear as proposed legislation next year,” Luscombe said.
Two Possible Replacements
The Advisory Panel actually presented two plans as possible replacements for the current Internal Revenue Code: The Simplified Income Tax Plan, which is their chief recommendation, and a Growth and Investment Plan.
Under both plans, the standard deduction, personal exemption, child credit and all itemized deductions would disappear, to be replaced by a “family credit” and a “home credit” based on mortgage interest paid on a principal residence, up to certain limits. All taxpayers would be able to deduct their charitable contributions in excess of 1 percent of their income.
The earned income tax credit would be replaced by a work credit, but a host of other credits for individuals and businesses would disappear. About the only significant fringe benefit left standing would be employer-provided health care, but even some of that would be counted as taxable income if plans exceeded certain limits. The alternative minimum tax (AMT) would disappear.
The legion of tax-advantaged education and retirement savings vehicles under the current Internal Revenue Code would be replaced by three savings plans.
Under the Simplified Income Tax Plan, there would be four tax brackets: 15, 25, 30 and 33 percent. Dividends from U.S. corporations would not be taxed and 75 percent of capital gains from U.S. companies would be excluded from income, producing effective tax rates from 3.75 to 8.25 percent. Interest would continue to be taxed at ordinary rates.
The Growth and Investment Plan proposes three brackets for individuals: 15, 25 and 30 percent, with dividends, capital gains and interest all taxed at the lowest rate. It departs from the current system more in the way businesses, especially large businesses, would be taxed, moving the system closer to a consumption tax.
Is Simpler Better?
The Panel focused on reducing the functions of the tax system to raising revenue, and doing that as simply as possible, without distributing tax breaks to special interests or socially beneficial causes. For example, the Panel does away with the idea of deducting uninsured casualty losses – a tax benefit that many people will be taking advantage of after this year’s hurricanes.
“It’s true that a deduction for casualty losses benefits relatively few people in any year, and it benefits wealthier people more than the poor, but some may think it’s unfair that investors will still be able to write off their losses in the stock market while the victim of a flood won’t be able to get tax relief after losing their house,” Luscombe observed.
The Panel would sweep away a number of provisions that encourage certain kinds of saving and investment, but would seem to leave untouched some of the most convoluted parts of the Code, such as passive activity loss rules, at-risk rules and basis limits.
“The tax code may be a crude instrument for encouraging people to save energy or build low-income housing or help their employees finish college, but you have to wonder why it’s been used for those kinds of purposes so often,” Luscombe noted.
Who Wins, Who Loses?
Whether any of the Panel’s recommendations becomes reality will undoubtedly depend to a large extent on whether people think they will benefit personally from its provisions.
In many instances, people would pay just about the same tax under the proposed new system as under the current laws. But many of them would be people whose taxes are simple to begin with – they may take the standard deduction and not have to grapple with itemized deductions, the AMT and supplemental schedules and forms.
“As long as you’re a ‘generic’ taxpayer, you seem to come out all right under the proposed reforms, but if there’s something ‘special’ about your situation you could get hammered,” said CCH Senior Research Analyst Phillip Schwindt, CPA, who calculated a number of scenarios for taxpayers at various income levels. To view CCH tax scenarios, go to http://www.cch.com/taxreform.
For example, a married couple with two children and an adjusted gross income of $50,000 who took the standard deduction and who had no child care expenses would pay $150 less in tax under the Commission’s proposals. But if they currently have $6,000 in child care expenses and use the dependent care credit, their tax bill would climb by $1,050 under the proposal.
A Mixed Bag
Well-off taxpayers will find that the Panel’s proposals are a decidedly mixed bag. Many would benefit from the repeal of the AMT and investment income in the form of dividends and capital gains gets favorable treatment. But the family and home credits are likely to fall short of the benefits currently available to them through itemized deductions.
In addition, many of these taxpayers would find that things such as generous employer-provided health insurance and the mortgage interest on vacation homes lead to higher tax bills under the proposed system. In two scenarios calculated by CCH involving a family with $300,000 in income, a health plan valued at $15,000 produced a tax increase of over $1,000 compared to the same family but with a health plan valued at $11,000 or less.
Social Security beneficiaries will want to take a sharp pencil to the Panel’s proposals. Some will pay less tax, but a single person living on $20,000 in pension income plus $14,000 in Social Security benefits would pay $882 more under the proposed reforms.
The number of people and industries that perceive themselves to be harmed by the proposed reforms will probably determine the fate of the Panel’s proposals rather than the theoretical appeal of a simpler system, in Luscombe’s view.
“Those who see themselves being hurt by the new system are likely to fight hard to prevent it from being enacted. Many others might feel little pain, but will they be as passionate in favor of the reforms, just to save time and energy filling out their returns?” Luscombe said.
About CCH, a Wolters Kluwer business
CCH, a Wolters Kluwer business (tax.cchgroup.com), is a leading provider of tax, audit and accounting information, software and services. It has served tax, accounting and business professionals and their clients since 1913. Among its market-leading products are The ProSystem fx® Office, CCH® Tax Research NetWork™, Accounting Research Manager™ and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.
Wolters Kluwer is a leading multinational publisher and information services company. Wolters Kluwer has annual revenues (2004) of €3.3 billion, employs approximately 18,400 people worldwide and maintains operations across Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands (www.wolterskluwer.com). Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.