Tax reform, proposed legislation, proposed tax changes. House Ways and Means Committee Chairman Dave Camp (R-MI) released his proposal of a revamped Internal Revenue Code. While many give passage of this proposal no chance, it is worth exploring some of the provisions. The last “major” reform we had to the tax code was in 1986 when tax rates were compressed to 2 rates, 15% and 28%, many deductions were eliminated or significantly scaled back – remember being able to deduct credit card and other personal interest, and the “UNICAP” rules requiring businesses to capitalize more of their previously deductible costs into inventory and the complex passive loss rules that devastated many real estate investors were enacted. Here are some of the provisions in the Camp Tax Reform Proposal.
For individuals, the 5 current tax brackets (15%, 25%, 31%, 35%, and 39.6%) would be compressed to 2 – 10% and 25%. Well, read a little further into the details . . . there would also be a 10% surtax on high income individuals in essence creating a 35% bracket. This 10% surtax would apply on income over $450,000 for a couple and $400,000 for a single person, and it would apply to “modified” income which includes items that are either currently deductible or tax free, such as employer provided health insurance, 401(k) deferrals, the foreign earned income exclusion, and tax-free Social Security benefits. Also, to recapture the benefit of the 10% tax bracket, semi-high income individuals would have a 5% surtax beginning when income exceeds $300,000 for a couple and $250,000 for a single person – another unstated tax rate bracket.
Personal exemption deductions would be history, but the child tax credit would be increased to $1,500 per dependent under age 18 and $500 for older dependents. For those who do not itemize, the standard deduction would be increased to $22,000 for couples and $11,000 for a single person. The standard deduction would phase out for high income individuals, in this case defined as those with income over $517,500 for couples and $358,750 for a single individual.
Reverting to how long-term capital gains were treated many years ago, 40% of both capital gains and dividends from domestic companies would be excluded from income. Thus, the maximum rate would be 21% for those in the 35% bracket – but remember that the 3.8% Medicare surtax which started in 2013 and is technically not considered an income tax would still apply increasing that maximum rate to 24.8%.
What about the dreaded Alternative Minimum Tax that was originally enacted in 1969 to make sure 155 high income people paid some amount of tax – the tax that no one really understands, yet currently applies to millions of “middle income” taxpayers? Under the Camp proposal, it would be repealed entirely.
Itemized deductions would be significantly reduced. Here are some examples:
- State and local income tax deduction – completely eliminated.
- Medical expense deduction – completely eliminated.
- Alimony paid deduction – completely eliminated, although alimony received would no longer be taxable.
- Employee business expense deduction – completely eliminated.
- Mortgage interest would only be deductible on up to $500,000 of debt, and interest deductions on new home equity loans would be completely eliminated.
- Charitable donations would only be deductible to the extent they exceed 2% of one’s income, and the special benefit allowing appreciated property to be deducted at the fair market value would be eliminated.
Some other changes affecting individuals include:
- Phase out of the home sale exclusion which currently allows couples to treat up to $500,000 of gain on the sale of their home as tax free.
- Education credits would be consolidated into one credit, and that credit would begin to phase out for couples with income over $86,000 and for a single individual with income over $43,000.
- Many tax credits would be eliminated including the dependent care credit and the adoption credit.
- Retirement savings would be changed. No additional contributions would be allowed to traditional IRAs, and deductions to 401(k) accounts would be reduced to 50% of the current allowed amounts. Roth contributions would be expanded. Also, many inherited retirement accounts would need to be distributed within five years of the death of the original owner.
On the business side, there would also be significant changes. The top corporate rate (after a phase in period) would be 25%. Accelerated depreciation would be replaced with straight line depreciation and there would be 14 recovery periods for different types of property. For example, both residential (currently 27 ½ year recovery period) and non-residential (currently 39 year recover period) buildings would be depreciated over 40 years. Businesses could elect to take inflation into account in calculating depreciation and could also expense up to $250,000 of new purchases annually, subject to phase outs.
Shareholders who materially participate in S corporations would have to pay self-employment tax on part of the earnings – 70% of combined compensation and share of income would be considered to be self-employment income.
Income from certain partnership interests that are held in connection with the performance of services would be required to be recharacterized as ordinary income. (This is currently called the carried interest loophole since such income is presently considered capital gain income.)
Other business provisions would be changed. Here are some examples:
- Tax-free like-kind exchanges – completely eliminated,
- The work opportunity tax credit – completely eliminated.
- The net operating loss deduction – limited to 90% of current income.
The congressional Joint Committee on Taxation scores this tax reform proposal as essentially revenue-neutral; that is, it neither increases nor decreases the total tax to the Federal Government.Tax reform … proposed legislation … proposed tax changes … REMEMBER these are only proposals . . .
For more information, email julie@meara.com.