Selected Discussions Of Federal Tax Reform Panel Recommendations

AREAS OF DISCUSSION:
Introduction
Home Mortgage Interest
Charitable Contributions
Alternative Minimum Tax

Introduction
President Bush created a bipartisan panel to review reforming the income tax code. It is a widely held belief that the income tax code has become too complicated, and in response to this complication, too many taxpayers must hire tax professionals to prepare income tax forms, and provide consulting services in order for them to save on income taxes. The panel also felt that savings and investment in the United States is lower than most industrialized nations. Thus, it is the panels ultimate goal to make the income tax code simpler, while simultaneously creating impetus for saving and investment.

Panel Recommendation. The Panel came up with two plans for accomplishing these goals. Though many refer to these plans as Plan A and Plan B, the Panel created “The Simplified Income Tax Plan” which would streamline the current tax system. “The Growth and Investment Tax Plan” reduces the tax burden on saving and investment to boost economic growth without changing how the tax burden is distributed. This would move our current tax system closer to a consumption tax and impose a flat tax on capital income.

Home Mortgage Interest
Current Law. The housing sector is a highly favored area by our tax code. Taxpayers are allowed to deduct interest paid on up to $1 million of mortgage debt secured by the taxpayer's first or second home. In addition, homeowners may deduct interest on home equity loans of up to $100,000. It is the Tax Reform Panel's view that when coupled with the deduction of real estate taxes, and the exclusion of capital gains on sales of your residence, that the tax code encourages "overinvestment" in housing at the expense of other productive uses.

Panel Recommendation. The Panel recommends that the deduction for mortgage interest be replaced with a Home Credit available to all homeowners. The Home Credit would be equal to 15% of mortgage interest paid by taxpayers on a loan secured by the taxpayer's principal residence and used to acquire, construct, or substantially improve that residence. Further, the Panel recommends limiting the amount of the Home Credit based on the average cost of housing within the taxpayer's area. And lastly, the Panel recommends that the length of time an individual must own and use a home as a principal residence to qualify for the tax exemption be increased from two out of five years to three out of five years.

So, what does this mean? For taxpayers in tax brackets lower than 15%, this could be a very nice benefit. However, for folks in tax brackets above 15%, this could be detrimental. You will no longer be able to deduct interest on a secondary residence (vacation homes). The credit you will take is based on an average of home costs within your area, as opposed to the actual amount you expend in mortgage interest. And lastly, for those who move from home to home frequently, you will need to reside in a residence another year longer, just to be able to exclude the capital gains on the sales of the residence.

Charitable Contributions
Current Law. Currently, taxpayers are limited to either 50% or 30% of Adjusted Gross Income (“AGI”) for the amount of charitable contributions they may include as Itemized Deductions, in any given year (notwithstanding provisions of the tax law as a result of Hurricane Katrina). If the taxpayer exceeds the amount allowable by this computation, they may carryover the otherwise non-deductible contributions to another year.

Panel Recommendation. The Panel recommended that a high enough portion of taxpayers make contributions to charities, that they would retain a tax benefit for charitable giving, and make it available to all taxpayers whether or not they itemized their deductions in a given year. Thus, they created a deduction of 1% of AGI for charitable contributions available to all taxpayers. In the event that a taxpayer gives more than 1% of their AGI, they may deduct that excess. The Panel recommended that the tax benefit be structured to provide additional incentives to those taxpayers in high income brackets, because they felt that this is too important of a donor base to lose the contribution.

So, what does this mean? It means that everyone will be given a deduction for charitable contributions, and those who contribute greater than 1% of their AGI will get to deduct that excess. For those taxpayers who do not contribute 1% of their AGI, this is a bonus, because they will be credited with the contribution, whether or not they make it. For those taxpayers who are more charitable with their giving, there will be no change.

Alternative Minimum Tax
The Alternative Minimum Tax (“AMT”) is one of the greatest examples of just how complicated our current income tax system is. Basically, taxpayers are required to compute their income taxes under two sets of rules, and then to be taxed under the higher of the two computations. It is estimated that 21.6 million middle-class taxpayers in 2006 will report an AMT liability.

Panel Recommendation. Under both of the Panel’s recommendations, the AMT would be repealed.

So, what does this mean? Before you skip through this section because you feel as though the meaning of repeal of the AMT is obvious, please remember that one of the goal’s of the tax panel is revenue neutrality. Creating a revenue neutral proposal means that when the Panel takes away a tax that the Government thinks the taxpayer will be paying, they must replace that tax somehow, someway. A great example of revenue neutrality due to the repeal of the AMT is to limit the home mortgage interest deduction, which has been addressed above.

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