Presidential panel recommends changes to how individuals and businesses pay taxes

President Bush’s Advisory Panel on Federal Tax Reform proposed its final recommendations earlier this month and they are extensive.

Despite earlier talk of scrapping the Tax Code in favor of a national consumption tax or a value-added tax, the panel is recommending significant but not drastic changes to the Tax Code. Our basic income tax system, together with its fundamental progressive nature, would be preserved, although changed in many ways.

The Tax Reform Panel’s recommendations, of course, may not be followed. Many in Congress have their own ideas on how reform should proceed and they certainly will have their say before a final tax reform bill is drafted. However, any movement away from the tax system recommended by the panel will now have an uphill battle.

Goodbye to the Alternative Minimum Tax

As expected, the panel recommended abolishing the alternative minimum tax (AMT) for individuals. The panel also went further in its final report and recommended eliminating the corporate AMT as well.

Many changes for individual taxpayers

The panel made two recommendations for simplifying the current marginal tax rates. Under the first plan (which is being called the Simplified Income Tax Plan), there would be four tax brackets (15, 25, 30, and 35 percent). Under the second plan (dubbed the Growth and Investment Tax Plan), there would be three (15, 25 and 30 percent).

The panel also proposed replacing the current personal exemption, standard deduction and child tax credit with a new “Family Credit” available to all taxpayers:

  • $3,300 for married couples;
  • $2,800 for unmarried individuals with a child;
  • $1,650 for single taxpayers;
  • $1,150 for dependent taxpayers;
  • $1,500 for each child; and
  • $500 for each other dependent.

All taxpayers would be able to purchase health insurance with pre-tax dollars up the amount of the average premium. The panel estimated average premiums to be $5,000 for an individual and $11,500 for a family.

The tax treatment of capital gains and dividends would also change. Under one proposal, capital gains and dividends would be taxed at 15 percent; under the other, dividends paid from domestic profits would be 100 percent exempt, while corporate capital gains would be 75 percent excludable.

New “Home Credit”

One of the panel’s most controversial recommendations would replace the current home mortgage interest deduction with a new “Home Credit.” The credit would equal 15 percent of mortgage interest paid. While the credit would be available to all taxpayers, the mortgage amount would be limited to the average regional price of housing (limits ranging from $227,000 to $412,000).

Simplified savings plans

The current plethora of retirement savings plans would be consolidated under the panel’s proposals. Defined contribution plans would be merged into “Save at Work” plans. All taxpayers would be able to participate in “Save for Retirement Accounts,” which would replace IRAs and similar arrangements.

Taxpayers also would be able to invest in new “Save for Family Accounts.” Money saved in these arrangements could be used for education and medical expenses, new home costs, and retirement.

Business taxation

On the business front, the panel made two sets of recommendations. One set would allow expensing for all new investments. Another set favored simplified accelerated depreciation.

Other business recommendations include:

  • Making interest paid nondeductible (except for financial institutions);
  • Making interest received non-taxable (except for financial institutions);
  • Taxing small business at a maximum 30 percent rate;
  • Lowering the corporate tax rate to 30 percent; and
  • Reforming the international tax system.

Stay Tuned

How will the Tax Reform Panel’s recommendations play out, both with President Bush and the Congress, as well as ultimately with the American people? While having the panel’s recommendations now makes predicting easier, the final outcome of tax reform remains uncertain. What is certain, however, is that it will change basic tax planning assumptions and that the new rules likely will start being effective on January 1, 2007. The sooner those changes can be anticipated, the earlier that tax planning—especially on long-term decisions—can take place. Our office will make sure you know where the reform debate is going.

IRS CIRCULAR 230 REQUIRED NOTICE
IRS Regulations require that we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended to be used and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for the purpose of promoting, marketing or recommending to another party any transaction or tax-related matter.