A
Quarterly Feature highlighting Sites of Interest
This
month we feature a press release from the AICPA
regarding CPA's Top Ten List for Uncovering Tax Breaks
CPAs' TOP TEN LIST FOR UNCOVERING
TAX BREAKS
NEW YORK (April 6, 1999) —
You don't have to look far for ways to cut your tax
bill. Following is a top ten list to guide you in uncovering
thousands of dollars in tax breaks you can claim on
your 1998 tax return.
YOUR CHILDREN
Beginning in 1998, a significant
new tax break is available to parents: They may
claim a child tax credit of up to $400 for each
qualifying child under the age of 17 as of December
31 of the tax year. The credit is phased out for
adjusted gross incomes (AGI) starting at $110,000
if married filing jointly or $75,000 if single.
The amount of the credit is reduced by $50 for each
$1,000 of AGI above the thresholds stated above.
In 1999, the tax credit is worth up to $500. If
you work and pay someone to care for your children,
you may also qualify for a dependent care credit.
This credit applies to child-care expenses of up
to $2,400 for one qualifying child, or $4,800 for
two or more qualifying children. The amount of the
tax credit ranges from 20% to 30% of child-care
expenses, depending on (AGI).
YOUR DEPENDENTS
You can claim a dependency exemption
of $2,700 for each qualified dependent. Generally,
a dependent must be a relative or an individual
who lives with you for the entire year as a member
of your household and who does not file a joint
tax return. In addition, you must provide more than
half of a person's total support during the calendar
year and that person must have less than $2,700
of gross income for the year. However, the gross
income test does not apply to a child under the
age of 19 or a full-time student under age 24. The
dependent must also be a citizen of the United States
or his/her relative . (Be aware that phase-out and
other rules apply.)
YOUR HEALTH CARE COSTS
If you're a business owner, in
1998 you can deduct 45 percent of the cost of your
health insurance premiums (60 percent of the cost
is deductible in 1999). Taxpayers who have incurred
significant unreimbursed medical expenses can also
deduct those that exceed 7.5 percent of their adjusted
gross income.
YOUR CHARITABLE GIFTS
Whether you've made gifts of cash
or property to qualified charitable organizations,
you can claim an itemized deduction on your tax
return. If you gave appreciated capital gain property
held for more than one year, you may generally deduct
the current fair market value of the property at
the time of the gift, limited to 30 percent of your
AGI.
YOUR HOME
Homeownership may also open the
door to tax deductions. Mortgage interest and real
estate and property taxes are all deductible.
COLLEGE EXPENSES
Two new credits against federal
income taxes are now available. The first is the
Hope credit worth up to $1,500 a year (100 percent
of the first $1,000 of educational expenses and
50 percent of the next $1,000). It may be claimed
to defray the costs of the first two years of tuition
and fees for you, your spouse, or your dependent,
enrolled in a degree program at a college or vocational
school. As an alternative to the Hope credit, you
may elect the Lifetime Learning Credit. This credit
is equal to 20 percent of the first $5,000 of qualifying
expenses paid after June 30, 1998, up to a maximum
of $1,000 per family. A qualifying student is not
required to be in a degreed program. Be aware that
both credits phase out for couples filing jointly
with AGIs between $80,000 and $100,000 and for singles
with AGIs between $40,000 and $50,000.
INTEREST COSTS
While consumer interest on items
like credit card debt is not deductible, you can
deduct three other forms of interest: interest on
up to $1 million of home mortgage loans; interest
on up to $100,000 of home equity loans; and for
1998, up to $1,000 in interest on student loans.
The amount increases to $1,500 in 1999. The student
loan interest deduction, new for 1998, applies to
the first 60 months in which interest payments are
required and is subject to phase-out rules. Be aware
that mortgage and home equity interest are itemized
deductions. Student loan interest, on the other
hand, is a deduction from gross income to arrive
at AGI.
UNPAID LOANS
When you lend money to friends
or family and you're not repaid, you can recover
part of the bad debt through a tax deduction. These
are typically considered nonbusiness bad debts and
are deducted on Schedule D of your tax return as
a short-term capital loss. You can deduct this from
other capital gains if any, and $3,000 of other
income. Any balance is deductible as a capital loss
carryover in future years.
BUSINESS-RELATED MEALS AND ENTERTAINMENT
Dine out for business reasons,
bring along your spouse and that of your client
or customer if there is a clear business purpose,
and you may be entitled to a tax deduction, provided
you conducted business immediately prior to or after
the meal. Such unreimbursed business entertainment
and meal expenses are considered miscellaneous expenses,
which are deductible to the extent that they and
other miscellaneous expenses exceed 2 percent of
your adjusted gross income.
TAX HELP
Fees paid to tax advisors and preparers
also fall into the category of miscellaneous itemized
expenses. Only those amounts that exceed 2 percent
of your adjusted gross income are deductible. The
AICPA is the national professional organization
of CPAs with over 330,000 members in business and
industry, public practice, government and education.
The AICPA sets U.S. auditing standards and, along
with the Financial Accounting Standards Board (FASB),
U.S. accounting standards. The AICPA is the first
national, professional membership organization to
be ISO 9001 certified, in recognition of its quality
management and assurance practices.
As April 15 again approaches, many
taxpayers are already anticipating the headaches that
come with filing their tax returns. The American Institute
of Certified Public Accountants prescribes 10 tax
simplification cures that could go a long way towards
relieving the BIG HEADACHES experienced by
many taxpayers.
Headache #1 - Earned Income Tax
Credit. Childhood dreams turn into
adult nightmares for low-income parents trying to
figure out the earned income tax credit. The credit
has been changed 13 times since 1976 and now requires
taxpayers to wind their way through a maze of eligibility
tests and worksheets. This credit is one of the most
error prone, complex provisions of the individual
income tax.
Headache #2 - Individual Alternative
Minimum Tax. The alternative minimum
tax is the iceberg on the horizon sneaking up on unsuspecting
middle-income taxpayers as fast as the Titanic went
down. The number of taxpayers subject to the AMT is
escalating at a phenomenal rate. Many of these taxpayers
were not intended as targets of this tax.
Headache #3 - Individual Capital
Gains Tax. Taxpayers now need relief
from capital gains tax relief. The Taxpayer Relief
Act of 1997 added complexity to both capital gains
tax rates and holding periods. Don't start your spring
cleaning yet. You'll need records to show when you
bought and sold investments, not to mention a great
deal of patience (and a few aspirins) in filling out
the 1997 Schedule D.
Headache #4 - Marriage Penalty. There
are a lot of things that make marriage a plus or minus.
The tax law should not be one of them. The Internal
Revenue Code has over 60 provisions where tax liability
depends on whether a taxpayer is married or single.
Headache #5 - Phase-Outs Based
on Income Level. The multitude of phase-outs
based on income level makes calculating whether you
qualify for a tax benefit as predictable as an El
Niño winter. The numerous (and differing) dollar
ranges of income are based not only on what you made,
but also on a variety of ways to measure what you
made.
Headache #6 - Health Insurance
Premium Deduction. A self-employed
taxpayer could become ill just trying to figure out
his or her health insurance premium deduction. The
calculation is scheduled to change every year until
2007.
Headache #7 - Kiddie Tax. This
is not child's play. The so-called "kiddie tax" taxes
the unearned income of children under the age of 14
at the parents' tax bracket. It has grown up into
a very complicated calculation.
Headache #8 - Individual Estimated
Tax Safe Harbor. Nothing feels safe
about a "safe harbor" if it's here today and somewhere
else tomorrow. Under the current law, some taxpayers
will calculate estimated taxes on a percentage that
is set to rise, remain steady, jump, and then drop
over the next six years.
Headache #9 - Employee vs. Independent
Contractor. The "battle" is not between
employees and independent contractors — rather,
it's a three-way fight: Congress vs. the Internal
Revenue Service vs. small businesses. The rules relating
to the classification of a worker as an employee or
independent contractor are as clear as cement.
Headache #10 - Half Year Requirements. Only
the tax law celebrates a person's half-birthday. Where
else will you find concerns about whether someone
is 59 1/2 or 70 1/2? Eliminating half-year requirements
is a gift from Uncle Sam all taxpayers would appreciate.
The AICPA is the national professional
organization of CPAs with more than 331,000 members
in public practice, business and industry, government
and education.
Attached is a technical analysis
of each of these taxpayer headaches and the AICPA's
solution or "relief" for all ten.
Relief #1 — Simplification
of Earned Income Tax Credit
Present law
The refundable EITC was enacted in
1975 with the policy goals of providing relief to
low-income families from the regressive effect of
social security taxes, and improving work incentives
among this group. According to the IRS, EITC rules
affect almost 15 million individual taxpayers.
Over the last few years, the most
common individual tax return error discovered by the
IRS during return processing has been the EITC, including
the failure of eligible taxpayers to claim the EITC,
and the use of the wrong income figures when computing
the EITC. The frequent changes made over the past
twenty years contribute greatly to the credit's high
error and noncompliance rates.
In fact, the credit has been changed
13 times (1976, 1977, 1978, 1979, 1984, 1986, 1988,
1990, 1993, 1994, 1995, 1996 and 1997). The credit
now is a nightmare of eligibility tests, requiring
a maze of worksheets. Computation of the credit currently
requires the taxpayer to consider 9 eligibility requirements:
the number of qualifying
children — taking into account relationship;
residency test;
age test;
the taxpayer's earned income — taxable and non-taxable;
the taxpayer's AGI;
the taxpayer's modified AGI;
threshold amounts;
phase out rates; and,
varying credit rates.
As part of the health insurance deduction
act that Congress passed in 1995, a new factor was
added to determining eligibility — the amount
of interest (taxable and tax-exempt), dividends, and
net rental and royalty income (if greater than zero)
received by a taxpayer, even if total income is low
enough to otherwise warrant eligibility for the EITC.
A threshold of this type of disqualified income was
set at $2,350 in 1995, but was then altered as part
of the Personal Responsibility and Work Opportunity
Reconciliation Act of 1996 to be $2,200. In addition,
in 1996, capital gain net income and net passive income
(if greater than zero) that is not self-employment
income were added to this disqualified income test.
In 1996, the credit computation became
even more complicated, with the introduction of a
modified AGI definition for phasing out the credit,
wherein certain types of nontaxable income need to
be considered and certain losses are disregarded.
Specifically, nontaxable items to be included are:
tax-exempt interest, and nontaxable distributions
from pensions, annuities, and individual retirement
arrangements (but only if rolled over into similar
vehicles during the applicable rollover period). The
losses that are to be disregarded are:
net capital losses (if greater
than zero);
net losses from trusts and estates;
net losses from nonbusiness rents and royalties; and
50 (changed to 75% in 1997 — see below) percent
of net losses from businesses, computed separately
with respect to sole proprietorships (other than in
farming), sole proprietorships in farming, and other
businesses — but amounts attributable to business
that consist of performance of services by an individual
as an employee are not taken into account.
In addition to the prior requirement
that a taxpayer identification number (TIN) be supplied
for all qualifying children, starting in 1996, individuals
are also required to be authorized to be employed
in the U.S. in order to claim the credit, and failure
to provide a correct TIN is now treated as a mathematical
or clerical error.
In 1997, as part of the Taxpayer Relief
Act of 1997 (TRA '97), additional restrictions are
placed on the availability of the EITC. For example,
taxpayers who improperly claimed the credit in earlier
years are denied the credit for a period of years.
If the improper claim was due to fraud, the disallowance
period is ten years after the most recent tax year
for which the final determination is made. If it was
due to reckless or intentional disregard of the rules,
the disallowance period is two tax years after the
most recent tax year for which the final determination
was made. Taxpayers who are denied the EITC for any
tax year as a result of tax deficiency procedures
must demonstrate eligibility for the credit and provide
additional information to the IRS in order to claim
the credit in any later tax year.
In addition, the 1997 law provides
that the amount of net losses from carrying on trades
or businesses that is disregarded in determining modified
AGI is increased from 50% to 75%. The 1997 legislation
also includes the following items in determining modified
AGI for the credit:
tax-exempt interest received or
accrued during the tax year; and
non-taxable distributions from pensions, annuities,
or individual retirement plans (if not rolled over
into similar vehicles during the rollover period).
Additionally, the 1997 law provides
that workfare payments are not earned income for EITC
purposes.
To claim the credit, the taxpayer
may need to complete:
a checklist (containing
8 complicated questions);
a worksheet (which has 9 steps);
another worksheet (if there is self-employment income);
a schedule with 6 lines and 2 columns (if qualifying
children are claimed); and
usually, the normal Form 1040 (rather than Form 1040EZ).
For guidance, the taxpayer may refer
to 7 pages of instructions (and 39 pages of IRS Publication
596). The credit is determined by multiplying the
relevant credit rate by the taxpayer's earned income
up to an earned income threshold. The credit is reduced
by a phaseout rate multiplied by the amount of earned
income (or AGI, if less) in excess of the phaseout
threshold.
While Congress and the IRS may expect
that the AICPA and its members can comprehend the
many pages of instructions and worksheets, it is unreasonable
to expect those individuals entitled to the credit
(who will almost certainly NOT be expert in tax matters)
to deal with this complexity. Even our members, who
tend to calculate the credit for taxpayers as part
of their volunteer work, find this area to be extremely
challenging. In fact, we have found that the EITC
process can be a lot more demanding than completing
the Schedule A — Itemized Deductions, which many
of our members complete on a regular basis for their
clients.
Our analysis suggests that most of
the EITC complexity arises from the definitional distinctions
in this area. While each departure from definitions
used elsewhere in the Code can be understood in a
context of accomplishing a specific legislative purpose,
the sum of all the definitions variances causes this
Code section to be unmanageable by taxpayers and even
the IRS. We recognize that many of the additions and
restrictions to the credit over the years were for
laudable purposes. However, the rules are so complex
that the group of taxpayers to be benefited find them
incomprehensible and are not effectively able to claim
the credit to which they are entitled.
Suggested changes
We recommend that Congress adopt the
following changes to the EITC:
A. Simplify definitions and the
calculation.
B. Define "earned income" as taxable
wages (Form 1040, line 7) and self-employment income
(Form 1040, line 12).
C. Modify the "qualifying child"
rules.
1. Replace the "qualifying child"
definition with the existing "dependent child"
definition.
2. Increase the incremental amount
of credit provided for two children versus one
child.
3. Use the dependency exemption
rather than the EITC to provide benefits for children.
D. Combine and expand the denial
provision.
1. Deny the credit for taxpayers
with: foreign earned income, alternative minimum
tax liability, and AGI that exceeds earned income
by $2,200 or more.
Contribution to simplification
Instructions and computations would
be greatly simplified. The error rate should be dramatically
reduced.
Relief #2 — Simplification of the Individual
Alternative Minimum Tax
Present law
Our tax laws give special treatment
to certain types of income and allow special deductions
for certain types of expenses. These laws enable some
taxpayers with substantial economic income to significantly
reduce their regular tax. The purpose of the AMT is
to ensure that these taxpayers pay a minimum amount
of tax on their economic income.
The AMT is one of the most complex
provisions in the tax system. Each of the adjustments
of Internal Revenue Code (IRC) section 56, and preferences
of IRC section 57, requires computation of the income
or expense item under the separate AMT system. The
supplementary schedules used to compute the necessary
adjustments and preferences must be maintained for
many years to allow the computation of future AMT
as items "turn around."
Generally, the fact that AMT cannot
always be calculated directly from information on
the tax return makes the computation extremely difficult
for taxpayers preparing their own returns. This complexity
also calls into question the ability of the Internal
Revenue Service (IRS) to audit compliance with the
AMT. The inclusion of adjustments and preferences
from "pass through" entities also contributes to the
complexity of the AMT system.
Several items enacted in TRA '97 will
have a dramatic effect on a number of individuals
who will find themselves shifting from the regular
tax system to the alternative minimum tax (AMT) system.
For many, this will come as a real surprise, and in
all likelihood, will cause substantial concern to
the IRS, which will have to focus significant efforts
to this area in the future to enforce compliance,
educate taxpayers, and handle taxpayer questions.
In fact, John Scholz, Deputy Assistant
Secretary in the Treasury Tax Policy Analysis Office,
has stated that the number of taxpayers subject to
the AMT, which is currently less than one percent,
is expected to escalate at a rate of 30 percent a
year for at least ten years. He noted that the trend
will mean eight percent, or 11 million taxpayers,
will be subject to AMT by 2007.
Most sophisticated taxpayers understand
that there is an alternative tax system, and that
they sometimes wind up in its clutches; the unsophisticated
taxpayer may never have heard of the AMT, certainly
does not understand it, and has no expectation that
he or she is ever going to have to worry about it.
Unfortunately, that is changing — and fairly
rapidly — since a number of the more popular
items, such as the education and child credits that
were recently enacted, only offset regular tax and
do not offset AMT. Due to these changes, we believe
it is most important that Congress obtain information
(from Treasury, the Joint Committee on Taxation staff,
or OMB) not only as to the revenue impact of the interaction
of all these recent tax changes with the AMT, but
also of the likely number of families or individuals
that will be paying AMT as a result of 1997's tax
legislation.
Specifically, taxpayers' situations
were exacerbated by the following.
2. Under the Hope tuition tax credit,
middle-income families receive up to a $1,500 credit,
per eligible student, for regular tax purposes,
though none of the credit is available against AMT.
The same is true with respect to the Lifetime Learning
Credit, with a maximum $1,000 credit before 2003,
and $2,000 credit thereafter. These credits alone
will generate a substantial number of new AMT filers.
Combine a child in the first or second year of college
with others at home below 17 years of age, and the
result is a potentially significant new group of
taxpayers who would under no circumstances be considered
rich, but who will now be paying the alternative
minimum tax.
It is becoming more widely known that
the failure to index the AMT brackets and exemption,
while regular tax brackets and exemptions are indexed,
will come close to quadrupling the number of individual
taxpayers subject to AMT in the next ten years. We
urge Congress to index the AMT brackets and exemption
amounts.
While we have not undertaken detailed
studies ourselves, anecdotal examples exist that indicate
the possibility that taxpayers with adjusted gross
incomes in the $60,000-$70,000 range can be subject
to AMT. Aside from the fairness issues involved —
this is not the group that the AMT has ever been targeted
to hit — we see some potentially serious problems
of compliance and administration as well. Many of
these taxpayers have no idea that they may be subject
to the AMT (if, indeed, they have any familiarity
with the fact that there is an AMT). Thus,
we anticipate large numbers of taxpayers not filling
out a Form 6251 or paying the AMT, thus requiring
extra enforcement efforts on the part of the Internal
Revenue Service to make these individuals (most of
whom will be filing in absolute good faith) aware
of their added tax obligations.
Suggested changes
We wish we had "the" answer to the
problem, but recognize there is no simple solution
given the likely revenue loss to the government. As
a start, however, Congress might consider:
1. Indexing the AMT brackets and
exemption amounts.
2. Eliminating itemized deductions
and personal exemptions as adjustments to regular
taxable income in arriving at alternative minimum
taxable income (AMTI) (e.g., all — or possibly
a percentage of — itemized deductions would
be deductible for AMTI purposes).
3. Eliminating many of the AMT preferences
by reducing for all taxpayers the regular tax benefits
of AMT preferences (e.g., require longer lives for
regular tax depreciation).
4. Allowing certain regular tax
credits against AMT (e.g., low-income tax credit,
tuition tax credits).
5. Providing an exemption from AMT
for low and middle-income taxpayers with regular
tax AGI of less than $100,000.
6. Considering AMT impact in all
future tax legislation.
Due to the increasing complexity and
compliance problems, and a perceived lack of fairness
towards the intended target, Congress might want to
consider the additional alternative of eliminating
the individual AMT altogether.
Contribution to Simplification
The goal of fairness that is the basis
for AMT has created hardship and complexity for many
taxpayers who have not used preferences to lower their
taxes but have mathematically been caught up in AMT's
attempt to bring fairness. Many of these individuals
are not aware of these rules and complete their return
themselves, causing confusion and errors. The 1997
law and the inflation of tax brackets are causing
more lower income taxpayers to be inadvertently included
in AMT. Recommendation 1 of indexing the AMT brackets
and exemption would solve this problem.
Under recommendation 2, those individuals
who are affected only by itemized deductions and personal
exemption adjustments would no longer have to compute
the AMT amount. We note that itemized deductions are
already penalized by the 3 percent AGI adjustment,
2 percent AGI miscellaneous itemized deduction adjustment,
and the 50 percent disallowance for meals and entertainment.
Similarly, the phase out of exemptions already affects
high income taxpayers. It is also worth noting that
because state income taxes vary, taxpayers in high
income tax states may incur AMT solely based on the
state in which they live, while other taxpayers with
the same adjusted gross income (AGI), but who live
in states with lower or no state income taxes, would
not have any AMT.
In addition, under recommendation
3, many of the AMT preferences could be eliminated
by reducing for all taxpayers the regular tax benefits
of present law AMT preferences (e.g., require longer
lives for regular tax depreciation). This would add
substantial simplification to the Code, record keeping
and tax returns.
Under recommendation 4, those who
are allowed certain regular tax credits, such as the
low income or tuition tax credits, would be allowed
to decrease their AMT liability by the credits. This
would increase simplicity and create fairness. Compliance
would be improved.
Under recommendation 5, fewer taxpayers
will be subject to AMT and the associated problems.
By increasing the AMT exemption to exclude low and
middle income taxpayers, the AMT will again be targeted
at the high-income taxpayer to whom it was originally
intended to apply.
By eliminating AMT altogether, all
the individual AMT problems would be solved.
Relief #3 — Simplification
of the Individual Alternative Capital Gains Tax
Present Law
The taxation of capital gains is extremely
complex, involving definitions and special rules of
what are capital assets, holding periods required,
and the alternative rates of tax depending upon the
holding period. TRA '97 added complexity in the area
of rates and holding periods. Net gains from the disposition
of capital assets are taxed at the following maximum
rates:
Holding
Period
Maximum
rate
28%
or + bracket
15%
bracket
One
year or less
28%,
36%, or 39.6%
15%
More
than one year but not more than 18 months
28%
15%
More
than 18 months
20%
10%
More
than five years (if acquired after 2000)
18%
8%
More
than five years (regardless of when acquired)
n/a
8%
More
than five years (if acquired before 2000 and taxpayer
elects to recognize gain on assets held as of
January 1, 2001
18%
n/a
More
than 18 months - real property depreciation recapture
25%
15%
More
than one year - Collectibles
28%
15%
Suggested Change
There should be one holding period
and one alternative capital gains tax rate, such as
more than twelve months and 20 percent, either or
both of which could be modified depending upon revenue
considerations.
Another suggestion is that the changes
to holding periods be implemented through changes
to section 1222, which already defines holding periods.
Contribution to Simplicity
With the different holding periods
and rates for capital gains, Schedule D of Form 1040,
together with instructions, has become unduly complex.
Having one holding period and one capital gains tax
rate will simplify tax law and tax reporting and will
improve compliance. Taxpayers have needed capital
gains tax relief, but without the needless complexity.
Changing the definition of long-term via section 1222
rather than changing the taxing/holding scheme via
section 1(h) would be simpler. The section 1222 definition
is still relevant for various provisions, such as
section 170(e).
Relief #4 — Eliminate the
Marriage Penalty
Present Law
Under the current tax system, a "marriage
penalty" and "marriage bonus" exist. The "marriage
penalty/bonus" results when two married individuals
have a greater (penalty) or smaller (bonus) tax liability
as compared to two similarly situated single individuals
(i.e., individuals with the same total incomes). The
marriage penalty is a likely, unintended result from
prior legislative efforts to be equitable. As each
Congress introduces changes to the Code, complexity
and unintended tax effects often result.
There are also at least 63 provisions
in the Internal Revenue Code where tax liability depends
on whether a taxpayer is married or single. Most of
these differences were created to be fair; to target
benefits to specific taxpayers, or to prevent abuses.
Some examples are the tax rates, standard deduction,
and earned income tax credit, as well as social security
benefits taxation, capital loss limits, IRAs, dependent
care credit, child credit, and education tax incentives.
The two major factors that have created
the marriage penalty problems are:
1. The "stacking of income" problem,
resulting from the different and progressive tax
rate/bracket schedules applicable to different filing
statuses, and
2. Different income thresholds and
phase-outs of deductions and credits for single
versus married taxpayers.
The progressive tax rate/bracket schedules
impose a higher marginal tax on combined spousal earnings,
as compared to two single persons. Additionally, the
tax brackets for married filing joint are not twice
as wide as those for single taxpayers, and the tax
brackets for married filing separately do not equate
to the tax brackets for single taxpayers. We refer
to this phenomenon as the "stacking of income" problem
and there are a variety of ways to address it.
The second factor contributing to
the marriage penalty is the large number of provisions
that phase-out based on income levels that may or
may not differ based on marital/filing status. TRA
'97 significantly increased the provisions with different
phase-outs for different filing status (i.e., based
on joint, single, or married filing separately).
There are also related joint liability
issues. For example, when a married couple files a
joint federal income tax return, each spouse becomes
individually responsible for paying the entire amount
of tax associated with that return. Because of this
joint and several liability standard, one spouse can
be held liable for tax deficiencies assessed after
a joint return was filed that were solely attributable
to actions of the other spouse. The current "innocent
spouse" relief provisions are not effective, are too
restrictive to help very many aggrieved taxpayers,
and are in need of reform. In addition, due to the
high divorce rate in this country, the current divorce
taxation rules affect a large percentage of taxpayers
inequitably, many of whom do not have or cannot afford
sophisticated tax advice.
A number of bills have been introduced
in Congress addressing the marriage penalty and joint
liability problems, including:
HR 2593 (Herger, R-CA), providing
a two-earner deduction up to $3,000;
HR 2456 (Weller, R-IL) / HR 2462
(Kasich, R-OH) / HR 3059(Jackson-Lee, D-TX) / S 1314
(Hutchinson, R-TX), allowing combined returns with
single rates;
S 1285 (Faircloth, R-NC), allowing
combined returns with single rates and allocating
half the taxable income to each spouse;
HR 1584 (Johnson, R-TX), providing
a $145 marriage penalty credit;
HR 2718 (Knollenberg, R-MI), eliminating
the marriage penalty in the standard deduction;
HR 2467 (Stupak, D-MI), allowing
divorce decree allocation; and
HR 2292 (Portman, R-OH) / S 1096
(Kerrey, D-NE), requesting a study of separate returns.
Recommended Change
The AICPA has been studying this area
for many years and recommends that the marriage penalty
be eliminated or reduced because it is inequitable.
There are a number of possible approaches to address
the marriage penalty problem.
1. Provide on one return, a separate
calculation of each spouse's taxable income and
use one tax rate schedule that would apply to all
individuals. The income and deductions of each spouse
could be allocated in a variety of ways, e.g., by
property ownership, by AGI, by percentage of earned
income, 50/50, or in the parties' discretion. In
our opinion, conceptually, this one-return, separate
calculation proposal could produce the most equitable
system. However, any allocation of income and
deductions adds complexity in return filing and
tax administration. The total increase in complexity
will depend on the allocation methods used. Many
states that have an income tax, such as Virginia,
use this approach. (This is similar to HR 2456 and
related bills.)
2. Provide a deduction to reduce
the marriage penalty, such as the two-earner deduction.
This would be the simplest solution to implement,
and would eliminate some, but not necessarily all,
of the marriage penalty and could add to marriage
bonuses. It would have to apply for regular tax
and alternative minimum tax (AMT) and not be subject
to an AGI phase-out to be fully effective. (This
is similar to HR 2593.)
3. Provide a tax credit to address
the marriage penalty. This would eliminate some,
but not necessarily all, of the penalty. It would
have to apply to both regular tax and AMT to be
fully effective. Several considerations would have
to be taken into account, such as the complexity
in the calculation, the treatment of carryovers
and carrybacks, and the priority ordering of the
many tax credits that could apply. (This is similar
to HR 1584.)
4. Adjust/broaden the current rate/bracket
schedules applicable to married individuals. The
joint schedule could be modified to eliminate the
marriage penalty (by increasing the joint brackets
to twice the single brackets) or to reduce the penalty.
Another approach would be to conform the married
filing separate and single rate/bracket schedules
(such as in Arizona). This approach would be better
than the current system and could be viewed as elective
complexity for those couples that chose to file
separately.
5. Adopt standard phase-outs for
three income levels — low, middle, and high
income taxpayers (rather than the 20 current levels),
and adopt one standard phase-out method. This would
eliminate marriage penalties, since the joint amounts
would be twice the single ranges, and the phase-out
ranges applicable to married filing separate taxpayers
would be the same as those for single taxpayers.
In addition, there are related tax
problems that arise because of marriage and joint
liability, and we urge the Committee to give these
matters consideration. For example, the innocent spouse
rules need modification, as do the treatment of carryover
tax attributes and NOL computations in divorce situations.
Further, we suggest Congress provide for allocated
liability instead of joint and several liability on
joint tax returns, and further consider separate returns
as an option. We also note that various Internal Revenue
Code regulations (i.e., under sections 108, 121, 154,
163, 1041, and 6013) regarding spouses and divorce
situations need to be amended.
This recommendation discusses a number
of possible approaches to address the marriage penalty
problem. However, each of these provisions needs to
be thoroughly analyzed in order to provide the economic,
tax, and social benefits that Congress determines
is appropriate. Further, to eliminate marriage penalties
and improve simplification, standard phase-outs (with
joint ranges being twice the single and married filing
separate ranges) for three income levels — low,
middle, and high income taxpayers (rather than the
20 current levels) — and one standard phase-out
method should be adopted.
Contribution to Simplification
By eliminating or reducing the marriage
penalty and marriage bonus the tax system would become
"marriage neutral." The tax system would be made more
rational and equitable.
Relief #5 — Elimination or Standardization
of Phase-Outs Based on Income Level
Present Law
Numerous sections in the tax law provide
for the phase-out of benefits from certain deductions
or credits over various ranges of income based on
various measures of the taxpayer's income. There is
currently no consistency among these phase-outs in
either the measure of income, the range
of income over which the phase-outs apply, or the
method of applying the phase-outs. Furthermore,
the ranges for a particular phase-out often differ
depending on filing status, but even these differences
are not consistent. For example, the traditional IRA
deduction phases out over a different range of income
for single filers than it does for married-joint filers;
whereas the $25,000 allowance for passive losses from
rental activities for active participants phases out
over the same range of income for both single and
married-joint filers. Consequently, these phase-outs
cause inordinate complexity, particularly for taxpayers
attempting to prepare their tax returns by hand; and
the instructions for applying the phase-outs are of
relatively little help. See the attached Exhibit for
a listing of most current phase-outs, including their
respective income measurements, phase-out ranges (for
1998) and phase-out methods.
Note that currently many the phase-out
ranges for married-filing-separate (MFS) taxpayers
are 50 percent of the range for married-filing-joint
(MFJ), while many of the phase-out ranges for single
and head of household (HOH) taxpayers are 75 percent
of married-joint. That causes a marriage penalty when
the spouses incomes are more equal.
Recommended Change
True simplicity could easily be accomplished
by eliminating phase-outs altogether. However, if
that is considered either unfair (simplicity is often
at odds with equity) or bad tax policy, significant
simplification can be achieved by creating consistency
in the measure of income, the range of phase-out (including
as between filing statuses) and the method of phase-out.
Instead of the at least 20 different
phase-out ranges (shown in attached Exhibit A), there
should only be three — at levels representing
low, middle, and high income taxpayers.
If there are revenue concerns, the
ranges and percentages could be adjusted, as long
as the phase-outs for each income level group (i.e.,
low, middle, high income) stayed consistent across
all relevant provisions. In addition, marriage penalty
impact should be considered in adjusting phase-out
ranges for revenue needs.
We have proposed that to eliminate
the marriage penalty and simplify the Code, all phase-out
ranges for married-filing-separate (MFS) taxpayers
would be the same as those for single and head of
household (HOH) taxpayers, which would be 50 percent
of the range for married-filing-joint (MFJ) range.
The benefits that are specifically
targeted to low-income taxpayers, such as the earned
income credit, elderly credit, and dependent care
credit, would phase-out under the low-income taxpayer
phase-out range. The benefits that are targeted not
to exceed middle income levels, such as the traditional
IRA deduction and education loan interest expense
deduction, would phase-out under the middle-income
taxpayer phase-out range. Likewise, those benefits
that are targeted not to exceed high income levels,
such as the new child credit, new education credits
and IRA, and the new Roth IRA, as well as the existing
law AMT exemption, itemized deductions, personal exemptions,
adoption credit and exclusion, series EE bond exclusion,
and section 469 $25,000 rental exclusion and credit,
would phase-out under the high-income taxpayer phase-out
range. See the chart below.
Additionally, instead of the differing
methods of phase-outs (shown in attached Exhibit B),
the phase-out methodology for all phase-outs would
be the same, such that the benefit phases out evenly
over the phase-out range. Every phase-out should be
based on adjusted gross income (AGI).
Proposed Income Level Range for
Beginning to End
of Phase-Out for Each Filing Status
Category
of Taxpayer
Married
Filing Joint
Single
& HOH & MFS
LOW-INCOME
$
15,000 - $ 37,500
$
7,500 - $ 18,750
MIDDLE
INCOME
$
60,000 - $ 75,000
$
30,000 - $ 37,500
HIGH
INCOME
$
225,000 - $ 450,000
$
112,500 - $ 225,000
Contribution to Simplification
The current law phase-outs complicate
tax returns immensely and impose marriage penalties.
The instructions are difficult to understand and the
computations often cannot be done by the average taxpayer
by hand. The differences among the various phase-out
income levels are tremendous. Either we should eliminate
phase-outs and accomplish the same goal with a lot
less complexity by adjusting rates, or at least make
the phase-outs applicable at consistent income levels
(only 3) and apply them to consistent ranges and use
a consistent methodology. This would ease the compliance
burden on many individuals. If there were only three
ranges to know and only one methodology, it would
be a lot simpler and easier to recognize when and
how a phase-out applies. Many portions of numerous
Internal Revenue Code sections could be eliminated.
By making the MFJ phaseout ranges double the ranges
applicable to single individuals and making the MFS
ranges the same as single individuals, the marriage
penalty relevant to phase-out ranges would be eliminated.
EXHIBIT A - Selected
AGI Phase-out Amounts
IRC Section
Provision
Ft
nt.
Current
-
Joint
Current
-
Single & HOH
Current
-
Married/Sep.
Proposed
-
Joint
Proposed
-Single
& HOH & MFS
PHASE-OUT LEVELS
FOR LOW-INCOME TAXPAYERS
21
30
Percent Dependent Care Credit
(3)
$10,000-$20,000
$10,000-$20,000
No
credit
$15,000-$37,500
$7,500-$18,750
22
Elderly
Credit
(4)
$10,000-$25,000
$7,500-$17,500
$5,000-$12,500
$15,000-$37,500
$7,500-$18,750
32
EITC
(No Child)
(2,3,
4)
$5,570-
10,030
$10,030
No
credit
$15,000-$37,500
$7,500-$18,750
32
EITC
(1 Child)
(2,3,
4)
$12,260-$26,473
$12,260-$26,473
No
credit
$15,000-$37,500
$7,500-$18,750
32
EITC
(2 or More Children)
(2,3,
4)
$12,260-$30,095
$12,260-$30,095
No
credit
$15,000-$37,500
$7,500-$18,750
PHASE-OUT LEVELS
FOR MIDDLE-INCOME TAXPAYERS
219
IRA
Deduction w/ retiremt. plan
(1,7,9)
$50,000-$60,000
$30,000-$40,000
No
deduction
$60,000-$75,000
$30,000-$37,500
221
Education
Loan
Interest Exp.
(1,2,6)
$60,000-$75,000
$40,000-$55,000
No
deduction
$60,000-$75,000
$30,000-$37,500
PHASE-OUT LEVELS
FOR HIGH-INCOME TAXPAYERS
24
Child
Credit
(1,5,6)
$110,000-
$75,000-
$55,000-
$225,000-$450,000
$112,500-$225,000
25A
Hope
Credit & Lifetime Learning Cr.
(1,2,6)
$80,000-$100,000
$40,000-$50,000
No
credit
$225,000-$450,000
$112,500-$225,000
23
& 137
Adoption
Credit/
Exclusion
(1,7)
$75,000-$115,000
$75,000-$115,000
No
benefit
$225,000-$450,000
$112,500-$225,000
55(d)
AMT
Exemption
(1,8)
$150,000-$330,000
$112,500-$247,500
$75,000-$165,000
$225,000-$450,000
$112,500-$225,000
68
Itemized
Deduction level
(2)
$124,500-
$124,500-
$62,250-
$225,000-$450,000
$112,500-$225,000
135
EE
Bond int. Exclusion
(1,2,7)
$78,350-$108,350-
$52,250-$67,250
No
exclusion
$225,000-$450,000
$112,500-$225,000
151
Personal
Exemption
(2)
$186,800-$309,300
$124,500-$247,000
HOH$155,650 -$278,150
$93,400-
$154,650
$225,000-$450,000
$112,500-$225,000
219(g)
(7)
IRA
w/spouse w/retrmt.plan
(1,6,7)
$150,000-$160,000
$10,000-$20,000
No
deduction
$225,000-$450,000
$112,500-$225,000
408A
Roth
IRA Deduction
(1,6)
$150,000-$160,000
$95,000-$110,000
No
deduction
$225,000-$450,000
$112,500-$225,000
408A
IRA
to Roth IRA Rollover
(1,6,7)
$100,000
$100,000
No
rollover
$225,000-$450,000
$112,500-$225,000
469(I)
$25,000
Rent
Passive Loss
(1,7)
$100,000-$150,000
$100,000-$150,000
$50,000-$75,000
$225,000-$450,000
$112,500-$225,000
469(I)
Passive
Rehab. Credit
(1,7)
$200,000-$250,000
$200,000-$250,000
$100,000-$125,000
$225,000-$450,000
$112,500-$225,000
530
Education
IRA Deductn
(1,6)
$150,000-$160,000
$95,000-$110,000
No
deduction
$225,000-$450,000
$112,500-$225,000
Footnotes: (1) Modifications
to AGI apply; (2) Inflation indexed; (3) Earned income
limitations; (4) Low income only; (5) Phase-out range
depends on number of children; (6) Newly enacted in
1997; (7) Also see section 221(b)(2); (8) Phase-out
applies to alternative minimum taxable income rather
than AGI; (9) Increases for future years are specifically
provided in the statute.
EXHIBIT B - Current Method of Phase-Out
Code
Section(s)
Tax Provision
Current Methodology for Phase-outs' Application
21
Dependent
Care
Credit
Credit
percent reduced from 30 percent to 20 percent
in AGI range noted by 1 percent credit for each
$2,000 in income
22
Elderly
Credit
Credit
amount reduced by half of excess over AGI range
23 &
137
Adoption
Credit
&Exclusion
Benefit
reduced by excess of modified AGI over lowest
amount noted divided by 40,000
24
Child Credit
Credit
reduced by $50 for each $1,000 in modified AGI
over lowest amount noted divided by 40,000
25A
Education
Credits
(Hope/Lifetime Lrng)
Credits
reduced by excess of modified AGI over lowest
amount divided by 10,000 (single) and 20,000 (joint)
32
Earned
Income Credit
Credit
determined by earned income and AGI levels
55
AMT Exemption
Exemption
reduced by 1/4 of AGI in excess of lowest amount
noted
68
Itemized
Deductions
Itemized
deductions reduced by 3 percent of excess AGI
over amount noted
135
Series
EE Bonds
Excess
of modified AGI over lowest amount divided by
15,000 (single), 30,000 (joint) reduces excludable
amount
151
Personal
Exemption
AGI in
excess of lowest amount, divided by 2,500, rounded
to nearest whole number, multiplied by 2, equals
the percentage reduction in the exemption amounts
219
Traditional
IRA w/
Retirement Plan
Individual
retirement account (IRA) limitation ($2,000/$4,000)
reduced by excess of AGI over lowest amount noted
divided by $10,000
219(g)(7)
IRA w/Spouse
w/
Retirement Plan
Deduction
for not active spouse reduced by excess of modified
AGI over lowest amount noted divided by 10,000
221
Education
Loan Interest
Expense Deduction
Deduction
reduced by excess of modified AGI over lowest
amount noted divided by 15,000
408A
Roth IRA
Contribution
reduced by excess of modified AGI over lowest
amount noted divided by 15,000 (single) and 10,000
(joint)
408A
IRA Rollover-Roth
IRA
Rollover
not permitted if AGI exceeds 100,000 or if MFS
469(i)
Passive
Loss Rental
$25,000 Rule
Benefit
reduced by 50 percent of AGI over lowest amount
noted
530
Education
IRA
Deduction
Contribution
reduced by excess of modified AGI over lowest
amount noted divided by 15,000 (single) and 10,000
(joint)
Relief #6 — Simplify Health Insurance Premium
Deduction
Present Law
Currently, self-employed individuals
are only allowed to deduct from gross income the following
portion of their health insurance premiums:
1997
40%
1998
- 1999
45%
2000
- 2001
50%
2002
60%
2003
- 2005
80%
2006
90%
2007
- and later
100%
This deduction is limited to the net
profit from self-employment minus the deduction for
one-half of self employment tax, Keogh, or SEP contribution.
So, if the earned income is a loss for the current
year then no deduction is allowed.
Also, the deduction is not allowed
for any month that the self-employed individual or
the spouse is eligible to participate in a subsidized
health plan maintained by an employer.
Recommended Change
The health insurance premium deduction
for self-employed individuals should be brought to
100%, or at least the deduction should be allowed
if the business sustains a loss for the year.
Contribution to Simplification
Currently, "C" corporations are allowed
to deduct 100% of health insurance premiums paid for
their employees including their employee-owners. Equal
treatment should be afforded to the self-employed.
This proposal carries some tax cost, but it will serve
the goal of providing health benefits to as many families
as possible by creating a tax incentive for the self-employed
to protect their families as well as the families
of their employees.
Relief #7 — Simplification of Kiddie Tax
Present law
The 1986 Tax Reform Act introduced
the so-called "Kiddie Tax" which taxes the unearned
income of children under the age of 14 at the parents'
bracket. While at first this seems to be straight
forward approach, it has evolved into a very complicated
calculation. When first proposed in 1986, there was
not a preferential tax rate for capital gains. The
introduction of the maximum 28% capital gain rate
has further complicated the situation. Under certain
limited circumstances, parents can elect to include
their children's income on their return. However,
the election in not available for parents of a child
with any earned income, unearned income in excess
of $5,000, capital gains, withholding or estimated
tax payments.
Instructions for utilization of Form
8615, "A Tax for Children Under Age 14 Having Investment
Income of More Than $1,200," cannot be contained on
the reverse of the form. Instead, the IRS has issued
Publication 929, a 22-page booklet which provides
the "hidden worksheets" that allow the taxpayer, or
the return preparer, to calculate the child's taxable
income, as well as the tax. In situations in which
there are multiple siblings falling underneath this
provision, the complexity expands. Similarly, if a
child is subject to the AMT, additional calculations
are required. In the overwhelming majority of situations,
the additional tax revenue generated by the "Kiddie
Tax" appears to be insignificant when compared to
the complexity of the calculations. Also, the Kiddie
Tax provision only considers the regular tax of section
1 and not the alternative minimum tax (AMT) of section
55. Therefore, the way the current rules are written,
if a parent must pay AMT, the children's income is
still taxed at the parent's regular marginal tax rate,
while the parent is taxed at the AMT rate without
taking into account the child's income or the child's
regular tax liability. This results in taxpayers paying
more tax than if the parent and children's income
are both included in the parent's AMT calculation.
Suggested Change
The linkage of a child's taxable income
to parents' and other siblings' taxable income should
be repealed. Income (other than capital gains) subject
to Kiddie Tax should be taxed at a separate rate schedule
(e.g., fiduciary income tax rates). The child's capital
gains would be taxed at the capital gains rates. The
election to include a child's income on the parent's
return should be expanded to allow all income, regardless
of its nature or amount, to be included. The election
could apply whether or not the child has withholding
or estimated payments. There could be a checkoff ,
similar to the current nominee interest checkoff,
or column added to the Form 1040 Schedules B and D
so as to indicate whether the item applies to another
social security number, in order to avoid any matching
problems.
Contribution to Simplicity
Removing the linkage to parental and
sibling returns would allow children's returns to
stand on their own. Issues regarding missing information
on one return, matrimonial issues, and unintended
AMT problems would be eliminated. The perceived loop-hole
of shifting income to minors would remain closed since
fiduciary income moves to higher tax brackets at lower
income levels than individuals.
Allowing across-the-board inclusion
of a child's income on a parent's return could eliminate
many children's returns and their associated compliance
burdens for taxpayers and the government.
Relief #8 — Simplification of the Individual
Estimated Tax Safe Harbor
Present Law
Individuals with adjusted gross incomes
of $150,000 or less may base their current year estimated
taxes on 100 percent of their prior year tax. As changed
by TRA '97, individuals with adjusted gross incomes
in excess of $150,000 may base their current year
estimated taxes on a percentage of their taxes for
the prior year as follows:
Current
Estimated Tax Year
Percentage
of Prior Tax Year
1998
100
1999
105
2000
105
2001
105
2002
112
2003
- and thereafter
110
Suggested Change
The percentage of prior year tax should
be 100 percent for all years.
Contribution to Simplicity
In general, the estimated tax rules
are complex. Prior to TRA '97, the provisions for
basing individual estimated taxes on their prior year
taxes were straight forward and simple. To change
to different percentages for different years results
in poor tax policy, and adds needless complexity.
By basing all estimates on the same percentage, such
as 100 percent of the prior year tax, the complex
calculations that are made quarterly by taxpayers
are reduced and simplicity is added to the Code.
Relief #9 — Simplification of Employee vs.
Independent Contractor
Present Law
The rules relating to classification
of a worker as an employee or independent contractor
are unclear. This results in needless confusion and
potentially large tax assessments for businesses who
are attempting to comply with the law.
Recommended Change
A bill (S. 460) simplifying the classification
of workers was introduced in the Senate on March 18,
1997 by Senator Christopher Bond (R-MO). This bill
establishes a safe harbor for employers classifying
workers as independent contractors when either of
the following two criteria are met:
A worker demonstrates economic
and workplace independence meeting a set of stipulated
criteria, and a written agreement exists between
the parties; or
A worker conducts business through
a corporation or limited liability company, the
worker does not receive benefits from the service
recipient, and a written agreement exists between
the parties.
A companion bill was introduced in
the House of Representatives by Rep. James Talent
(R-MO).
Contribution to Simplification
This is obviously a hotly-debated
issue within Congress, the Internal Revenue Service
and small business organizations. Until we are provided
with a clear-cut definition by Congress, this area
will continue to provide many uncertainties for small
business owners, as well as a continuation of the
many "battles" between taxpayers and the Internal
Revenue Service.
Even the Treasury Department has testified
that the 20-factor test, historically used by the
Internal Revenue Service to classify workers, is confusing
and "does not yield clear, consistent, or even satisfactory
answers, and reasonable persons may differ as to the
correct classification."
This issue has been chosen as the
top priority by many small business organizations,
including the 1995 White House Conference on Small
Business, the U.S. Chamber of Commerce, etc. The economic
ramifications of reclassification of a worker from
an independent contractor to an employee are significant.
Relief #10 — Simplification of Half Year Requirements
Present Law
The Internal Revenue Code uses 1/2
year age requirements to allow individual taxpayers
to begin to withdraw from their pension plans without
penalty. (Example, distribution must be made after
the taxpayer reaches age 59 1/2 to avoid penalty).
Recommended Change
Change the Internal Revenue Code by
eliminating the various Code sections that use 1/2
year requirements: A) Age 70 1/2 for mandatory IRA
distributions and B) Age 59 1/2 for penalty free retirement
plan withdrawals. Instead, use whole years: Age 70
and Age 59.
Contribution to Simplification
Many taxpayers, employers and banks
are confused when calculating this part of the requirement.
It would be easier to remember, calculate and administer,
and be more user-friendly if the ages were changed.
AICPA
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