Tax Reform Act aims to simplify US tax code
The House Ways and Means Committee released an almost 1,000-page discussion draft entitled Tax Reform Act of 2014. The stated purpose of the proposed legislation is to lower individual and corporation income tax rates, simplify the Internal Revenue Code and to change international tax rules. While it is unlikely to pass in its present form it does illustrate the thought process of the Republican majority in the House of Representatives.
House Ways and Means Committee
In an executive summary the House Ways and Means Committee argues that the goal of tax reform is to fix the tax code and to make it simple. Since 1986 the Tax Code has grown from 26,000 pages to 70,000 pages and the goal of the proposed legislation is to eliminate 25 percent of the tax code. The summary indicates that 90 percent of Americans either hire a tax preparer or purchase commercial software to prepare their tax returns. The goal of the proposed legislation is to change the tax code such that 95 percent of taxpayers will no longer have to itemise deductions. A secondary goal is to create 1.8 million new jobs.
There would be three marginal tax brackets. Ten percent on the first $71,199 of taxable income and 25 percent on taxable income between $71,200 and $400,000 for single taxpayers and 25 percent on taxable income between $71,200 and $450,000 for married taxpayers. A new ten percent surcharge (35 percent tax rate) is applicable to a more complex amalgamation entitled “Modified Adjusted Gross Income (MAGI).”
MAGI consist of income used to determine the phase-out of the ten-percent bracket. It also includes all income taxable at ten percent and 25 percent plus excluded foreign earned income, tax-exempt interest, employer-sponsored health insurance payments, self-employed health insurance deduction, pre-tax contributions to defined contribution retirement plans and medical savings accounts deductions.
Investment income such as long term capital gains and qualified dividends that are currently subject to a 20 percent maximum tax would be taxed as ordinary income but eligible for a 40 percent exclusion.
The standard deduction for single taxpayers will be $11,000 and $22,000 for married taxpayers. The standard deduction will be phased out for single taxpayers with MAGI in excess of $356,800 and married taxpayers with MAGI in excess of $513,600.
Personal exemptions will be eliminated for all taxpayers.
The deduction for medical expenses and long-term care insurance premiums and contributions to medical savings accounts will be eliminated.
Mortgage interest on loans up to $1,000,000 is currently deductible. The proposed legislation lowers this amount to $500,000 after a 4 year phase in. Existing loans are grandfathered. The deduction for interest on home equity loans of up to $100,000 is eliminated.
The investment interest deduction will be offset by tax exempt interest received.
Charitable contributions will be subject to a two percent disallowance and cannot offset more than 40 percent of a taxpayer's income.
The deduction for state and local income taxes is eliminated.
Numerous other credits and deductions will be eliminated. The more popular ones are:
Education provisions repealed include the US Savings Bond exclusion, student loan interest deduction, qualified tuition and expenses deduction, no new Coverdell contributions, exclusion of discharge of student loan indebtedness, qualified tuition reduction exclusion, exclusion for education assistance programmes and exception to ten percent penalty for early withdraws from retirement plans.
Credits repealed include the dependent care credit, adoption credit, residential energy efficiency credit, health insurance credit and the first-time homebuyer credit.
Deductions repealed include the deduction for tax preparation fees, alimony payments, moving expenses, the two percent floor on miscellaneous itemised deductions, the three percent of AGI overall limitation on itemised deductions, unreimbursed employee expenses, personal casualty loss deduction and losses from wagering.
The proposed legislation reduces by 50 percent the existing limits on employee pre-tax contributions to 401(k) plans, with the remaining 50 percent eligible to be contributed on an after-tax basis to a Roth account. In 2014, the limit on an elective deferral is $17,500. Under the proposed legislation a contributions in excess of $8,750 would be to a Roth account. Employers with more than 100 employees must offer Roth accounts in their plans.
Like kind exchanges- a popular tax planning tool for retirees looking to move to a warmer client is to swap residences tax free. For example, suppose a couple bought a residence 25 years ago at $500,000 and it is now worth $2 million. They want to invest the $2 million in a retirement home in Florida. If they sell the residence prior to a move to Florida they will be able to exclude $500,000 from the gain and they will pay tax of $200,000 on the taxable gain of $1 million plus state income tax. The tax planning is simple. Have the buyer of your current home buy the residence in Florida and then swap homes. This is a tax free transaction. The proposed legislation will eliminate this tax planning.
Senator Ron Wyden (Democrat-Oregon) is the new chairman of the Senate Finance Committee that is working on their version of tax reform. On an historical note in 2011 Sen Wyden advocated repealing Internal Revenue Code Section 911 better known as the foreign earned income and housing exclusions.
In my 40-plus years as a tax professional major tax reform used to be known as the accountant and attorney full employment act. The current proposed legislation will likely be known as the accountant and attorney unemployment act. Changing the tax code so that 95 percent of taxpayers will no longer have to itemise deductions is not difficult when you eliminate all the commonly used itemised deductions except charitable contributions and a diminished mortgage interest deduction. While the proposed legislation claims that it will generate 1.8 million new jobs, it does not state how many of these positions will be filled by out of work tax preparers. The House Ways and Means Committee report also highlights that the IRS erroneously paid out $132 billion in false tax claims in the past ten years with a significant portion of the false payments attributable to the child tax credit. However, there is nothing we saw in the proposed legislation to rectify this problem.
Estate and Gift Tax Exemption
The 2013 unified exclusion for estate and gift tax was $5.25 million and will increase to $5.34 million for 2014.
Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (I) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner. The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.
James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: firstname.lastname@example.org