Is Tax Reform Possible?
The Bowles-Simpson tax solution involved a substantial reduction in the rates by limiting itemized deductions or converting them to tax credits.
In response to the Simpson-Bowles proposal and those from members of Congress and presidential candidates, the Senate Finance Committee leadership met with the Joint Committee on Taxation (JCT). Committee Chair Max Baucus (D-MT) and ranking member Orrin Hatch (R-UT) requested a study by JCT of various tax reform options.
The JCT experiment discussed options if various tax expenditures were repealed. Based on the JCT analysis, there was only a small reduction in rates possible. However, other commentators noted that the JCT study did not consider all of the base-broadening strategies.
In response to the JCT study, Simpson and Bowles issued a joint statement and noted, “Nothing in the JCT analysis changes our belief that it is possible for tax reform to reduce rates and produce additional revenues if policy makers are willing to make the tough choices to eliminate or scale back tax expenditures.”
The Simpson-Bowles proposal showed a potential to reduce rates to 8%, 14% and 23% if there is a drastic reduction in other tax expenditures. The nonpartisan Committee for a Responsible Federal Budget (CRFB) also responded to the JCT study.
The CRFB analysis indicated that the Simpson-Bowles commission strategy could work if there is partial or total elimination of tax expenditures. Another CRFB analysis also indicated that there was a 2005 Treasury study by the President’s Advisory Panel on Tax Reform that claimed a combination of base-broadening and rate reduction is possible.
CRFB staff noted, “Although these two analyses differ in some respect, both show that the full elimination of all tax expenditures would allow the top tax rate to fall to 23% while still putting aside more than $1 trillion for deficit reduction.”
Editor’s Note: Your editor and this organization take no specific position on these tax reform strategies. The proposed major rate reduction plans all require significant limits on itemized deductions. Most strategies also tax capital gains at 28%. These changes will be difficult to pass during the major tax reform expected in 2013.
Tax Inflation Adjustments in 2013
Each year the IRS publishes multiple changes in various tax brackets and amounts that are increased to reflect the rate of inflation. In Rev. Proc. 2012-41; 2012-45 IRB 1 (18 Oct 2012), the IRS released the inflation-adjusted items for 2013.
There were moderate changes in many items. The following includes some of the more significant income tax adjustments.
1. Kiddie Tax – The exclusion for the Kiddie Tax for 2013 is increased to $1,000. For most children, net unearned income in excess of double the exclusion is taxed at the parent’s rate.
2. Savings Bonds for Higher Education – The phase-out for taxpayers receiving income from United States savings bonds used to pay for qualified higher education expenses will start at $112,050 for joint returns and $74,700 for other returns.
3. Medical Savings Accounts – For self-only coverage, the deductible may range from $2,150 to $3,200 and out-of-pocket expenses may not exceed $4,300. For family coverage, the deductible range is $4,300 to $6,450 and the expense limit is $7,850.
4. Token Benefits for Charitable Gifts – A low-cost item is defined as one that has a value of $10.20 or less. It should include the logo, colors or other identification of the charitable organization. Donors who make gifts in excess of $51 may receive a low-cost item and still qualify for a full deduction. A charity may give an insubstantial benefit to a donor provided that the benefit does not exceed 2% of the value of the gift or a maximum of $102.
There are also several provisions that affect gift and estate taxes.
1. Special Use Valuation – Under Sec. 2032A the qualified property may be reduced in value by up to $1,070,000.
2. Annual Exclusion – The present interest annual exclusion is increased to $14,000 in 2013.
3. Gifts to Non-Citizen Spouse – The applicable limit is $143,000.
4. Reduced Interest on Estate Tax – The installment estate tax “2% portion” for Sec. 6166 is $1,430,000.
Pension Plans in 2013
In IR 2012 77 (18 Oct 2012), the IRS announced multiple pension adjustments for 2013.
1. Elective Deferral – An individual with a 401(k) or 403(b) plan may defer income up to $17,500.
2. Catch-Up Contributions – Individuals age 50 and older may contribute an additional amount of $5,500 to a 401(k) or 403(b).
3. IRA Phase-Out – Contributions to a traditional IRA are phased out for individuals with a workplace retirement plan and modified adjusted gross incomes from $59,000 to $69,000. For married couples where the contributing spouse is covered by a workplace retirement plan, the phase-out range is $95,000 to $115,000. If the married couple IRA owner is not covered by a workplace plan, the phase-out range is $178,000 to $188,000.
4. Roth IRA Contributions – Taxpayers who are married may make Roth IRA contributions with a phase-out AGI of $178,000 to $188,000. Singles and heads of household have a phase-out range of $112,000 to $127,000.
Estate Tax Refund Affirmed
In Edith Schlain Windsor v. United States et al.; Nos. 12-2335, 12-2435 (2nd Cir. 2012), the court affirmed a District Court decision that awarded an estate tax refund to the survivor of a same-sex couple.
Theo Clara Spyer and Edith Schlain Windsor were married in Canada in 2007. Spyer passed away in 2009. The IRS denied a marital estate deduction based upon Section 3 of the Defense of Marriage Act (DOMA). The District Court reviewed the applicable law and determined that DOMA violated the equal protection clause.
The Bipartisan Legal Advisory Group of the United States House of Representatives (BLAG) retained counsel and appealed the decision of the District Court. BLAG maintains that there is a rational basis for DOMA that is sufficient to uphold its constitutionality.
In a split decision, two Circuit Court Judges determined that same-sex marriage partners qualified as a “quasi-suspect class” and therefore should receive heightened scrutiny. Under this standard, DOMA violates the equal protection clause.
BLAG maintained that Congress had a rational basis for preserving traditional marriage. However, the Circuit Court determined that the rationale for the Defense of Marriage Act was not sufficient under the heightened scrutiny standard and affirmed the District Court award of the estate tax refund.
Dissenting Judge Straub argued that DOMA does not violate the Fourteenth Amendment’s equal protection guarantee. In his view, the question of marriage should be determined by Congress and the American people, rather than by the courts.
Judge Straub referred to decisions by 11 Circuit Courts of Appeals that have refused to grant sexual orientation an elevated form of scrutiny. Because he would apply the rational basis test to DOMA, it passes the equal protection standard.
Applicable Federal Rate of 1.0% for November — Rev. Rul. 2012-30; 2012-45 IRB 1 (17 Oct 2012)
The IRS has announced the Applicable Federal Rate (AFR) for November of 2012. The AFR under Section 7520 for the month of November will be 1.0%. The rates for October of 1.2% or September of 1.0% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2012, pooled income funds in existence less than three tax years must use a 1.8% deemed rate of return. Federal rates are available by clicking here.