Many of these tax expenditures are quite popular with American taxpayers. Periodically, the Joint Committee on Taxation publishes the amounts of the tax expenditures. If the total value of all taxes saved through deductions is 100%, then each tax expenditure can be calculated in percentage terms. In effect, there is a pie graph that is equal to 100% and each tax expenditure can be calculated as a part of that pie.
Top tax expenditures include the following:
1. Health Insurance – Most health insurance is paid for by the employer and not taxable to the employee. This is the largest tax expenditure and equals 13% of the total.
2. Home Mortgage – Home mortgage interest is generally deductible with a $1 million mortgage limit. This is 9% of the total.
3. Capital Gains and Dividends – There is a 15% top rate for long-term capital gains and dividends. This is substantially lower than the ordinary income tax rate, which may be up to 35%. This tax expenditure is 8% of the total.
4. Medicare Benefits – While seniors pay a partial Medicare premium, most of the cost of Medicare is paid for by the government. This cost is tax-free to recipients and equals 7% of the total.
5. Pension Plans – Many pension plans are primarily funded by the employer, but some plans include a partial contribution by employees. A qualified plan enables those contributions to be made with pre-tax dollars. This equals 6% of the total.
6. Earned Income Tax Credits – Lower income families are permitted a refundable credit. This tax credit is 5% of the total.
7. State and Local Tax Deductions – Most tax payments to state and local governments are deductible on the federal return. This is a benefit that is particularly important for high-tax states. This tax expenditure is 5% of the total.
8. 401(k) Deductions – Most 401(k) plans have a pre-tax contribution by the employee. Many plans also include an employer match. This is 4% of the total.
9. Capital Gains in an Estate – Land, stock and homes may be appreciated in the estate. However, there typically is no capital gains tax if sold by the family at the estate value. This tax expenditure is 4% of the total.
10. Charitable Deductions – Donors may give cash or appreciated property to charity and receive a deduction. These deductions equal 4% of total tax expenditures.
Editor's Note: Congress and the White House are discussing a number of tax expenditures and various limits. The challenge with reducing the deductions for the largest tax expenditures is that these changes will impact many American taxpayers.
Sen. Conrad Releases Budget Proposal
Sen. Conrad stated, "Spending is the highest it has been in 60 years as a share of our national income. Revenue is the lowest it has been in 60 years as a share of our national income. Both have to be addressed if we are going to solve this problem."
The Conrad budget attempts to address the $4 trillion goal with one-half tax increases and one-half spending cuts. The proposed tax increases include an increased income tax rate of 39.6% for single persons with incomes of $500,000 and joint filers with incomes over $1 million. Capital gains taxes would be increased from 15% to 20%. Estate tax exemptions would be reduced from $5 million per person to the 2009 level of $3.9 million. There also would be indexing of the AMT exemption.
The Ranking Member on the Senate Budget Committee is Sen. Jeff Sessions (R-AL). He expressed concern about the tax increases in the Conrad plan. Sen. Sessions noted, "The top marginal tax rate for individuals would approach 50% when the effects of PEP/Pease, healthcare reform payroll and investment tax increases, and the proposed phaseout of itemized deductions are taken into account."
Editor's Note: The proposed budget is very likely to be substantially modified before enactment. However, it may provide discussion points for the President and Congressional Leaders in the ongoing budget negotiations.
Bypass Trust "Welfare" Distribution Permitted
The decedent's husband, Lester Chancellor, passed away in 1989. His will was probated in Mississippi and created a unified credit trust. The trust included an invasion power "for the necessary maintenance, education, healthcare, sustenance, welfare or other appropriate expenditures needed" by the decedent.
Ann Chancellor passed away November 16, 2004. The unified credit trust was valued at $1,205,034 on that date. The estate filed the IRS Form 706 and reported only the estate of Mrs. Chancellor of $1,383,405. IRS claimed that the "welfare or other appropriate expenditures" clause in the credit sheltered trust created a general power of appointment under Sec. 2041(b)(1) and issued a deficiency for $716,013.
The Court agreed that a general power of appointment under Sec. 2041(b)(1) requires the credit trust to be included in the estate. The primary issue is whether the "welfare or other appropriate expenditures" language creates a general power of appointment.
In a number of cases, similar phrases or language that included the words "happiness, desire or use and benefit" was held to create a general power. In most credit shelter trusts, the IRS observed that the customary language is invasion for "health, education, maintenance and support." Under most state law, this is deemed an ascertainable standard that does not create a general power of appointment.
However, the Chancellor power is preceded by the word "necessary." Under Mississippi law, the phrase "necessary...welfare or other appropriate expenditures" are words of limitation. The language is not a general power that permits invasion of the trust for unlimited purposes.
In the view of the Tax Court, the Mississippi Supreme Court would construe this clause in its entirety as an ascertainable standard. In addition, the provisions of the will also provide inheritance for children. Therefore, it appears that the intent of Mr. Chancellor was to provide his spouse with a power of invasion subject to an ascertainable standard.
The language is therefore determined to be a limited phrase that does not create a general Sec. 2041(b)(1)(A) power of appointment.
$1.24 Million Caregiver Deduction Denied
The decedent was in very poor health from the time of a fall in September of 1994 until she passed away on April 26, 2003. Her primary caregiver during that time was her son Antonio Olivo. He was an attorney who also had obtained an LLM in taxation from New York University School of Law. However, from 1994 through 2003 he earned no significant income from law practice and his primary focus was serving as caregiver for his mother.
She suffered from partial paralysis after the fall, required extensive medication and many visits to doctors and medical centers. She also required assistance for the activities of daily living, such as using the bathroom, dressing and bathing. The decedent was diabetic and required multiple insulin injections. Mr. Olivo was her primary caregiver, but he also employed home health aides.
Recognizing her serious medical condition and need for a caregiver, the decedent and Mr. Olivo had discussions about the potential for providing compensation to him. While there was some family acrimony between Mr. Olivo and his three siblings about the topic, when he offered to hire full-time nursing care for the decedent, they declined. Mr. Olivo claimed that he and decedent had agreed on a fee of $400 per day to be deferred and paid by her estate.
Mr. Olivo served as the executor, attorney and accountant for the estate. He was paid a fee of $44,200 as executor, $50,000 as attorney and $5,000 as the estate accountant. Mr. Olivo filed the IRS Form 706 and also claimed a deduction for caregiving in the amount of $1,240,000. The Probate Court had not approved that payment.
The Court noted that under New Jersey law, an oral promise is not enforceable in these circumstances unless there is clear and convincing evidence. The testimony by Mr. Olivo is not supported by any writing and fails even a "preponderance" standard.
The estate also claimed a recovery under a theory of quantum meruit. This legal theory provides recovery where there has been performance of services, acceptance of services by the decedent, an expectation of compensation and a determination of the reasonable value of the services rendered.
However, under New Jersey law, providing caregiving services by a family member is presumed to be without compensation. Mr. Olivo did not provide evidence that overcomes the presumption that his services were gratuitous. Therefore, the caregiving claim was denied.
The attorney fees and executor fees are permitted if documented and appropriate under New Jersey law. The executor fees were deemed appropriate, but the attorney fees in large part were not adequately documented and, therefore, the majority of those fees were denied.
