Economic Opportunity for Young People
Chairman Max Baucus (D-MT) opened with a quote from President Truman who stated, “All of us want our children to have a better life than we had and it should be the constant aim of each generation to make things better for the next.”
Baucus noted that children of lower-income families have many challenges in America. He stated that a child of a family in the top 10% of earners is “23 times more likely to end up financially well-off than a child born in the bottom 10%.” Baucus observed the U.S. is “dead last in mobility” among the nine other first world economies for children of lower-income families. Finally, the child in that higher-income family is 10 times more likely to complete college.
Sen. Orin Hatch (R-UT) is the Ranking Member of the Senate Finance Committee. He followed the comments of Sen. Baucus and suggested “The most important way to provide those opportunities is for parents to invest in early childhood development and education and to provide a stable family structure.” Hatch noted that the nation is continuing “to run up our federal debt and burdening our children and theirs with mountains of bills to pay off.” In his view, this debt is likely to lead to declining opportunities. He agreed with Baucus that “a clear path towards the better [solution] seems to be fundamental tax reform.”
Erin Currier of the Pew Trusts highlighted the importance of using tax incentives to encourage mobility. She pointed out that most of the current tax benefits go to higher income individuals. Approximately 70% of the various tax incentives benefit upper-income Americans. Because lower income Americans pay little or no income tax, they receive minimal benefits from tax incentives.
Witness Eugene Steuerle is an Institute Fellow at the Urban Institute. He focused on three specific challenges that face the government. First, he observed that the current budget promotes consumption rather than investment in young people. There are “ever-smaller shares of our tax subsidies and spending devoted to children” and larger expenditures each year for retirement and health programs.
Second, for lower-income persons, there are relatively high disincentives to work and save. Steuerle pointed to analyses by his organization that suggest fairly high tax rates on individuals who increase income from $15,000 per year to $35,000 per year. Because of the phase-outs of various tax benefits, the actual tax rate on the increased income in that range is approximately 50% to 60%. This high effective tax rate makes it difficult for individuals in very low income jobs to move through that range into higher-paying positions.
His third observation is that government spending and tax provisions are frequently focused on housing and pensions. While both are good concepts, the vast majority of the tax benefits for homeownership and retirement plans is enjoyed by those with higher incomes.
Editor’s Note: The continued series of hearings by the Senate Finance Committee is preparing the way for major tax reform in 2013. It is very helpful and positive for both parties to focus on practical ways the federal government can facilitate advancement of young people with lower incomes into the middle and upper income ranges.
White House and Congress Debate Tax Cut Extension
The White House this week proposed extending the 2001 and 2003 middle class tax cuts for one year. The tax cut extension would be limited to individuals with incomes below $250,000. The White House proposal includes a tax increase for upper-income taxpayers.
President Obama stated, “I believe that anybody making over $250,000 a year should go back to the income tax rates we were paying under President Bill Clinton, back when our economy was creating 23 million new jobs.” However, he suggested that the tax rates on middle class families should not be raised because “many folks are digging themselves out of the hole that was created by this Great Recession.”
Senate Majority Leader Harry Reid supported this proposal and stated, “I agree with President Obama that we should extend tax cuts for all American families up to the first $250,000 of income.” He suggested that this plan would protect the middle class and allow America “to reduce our deficit in a responsible manner.”
Speaker of the House John Boehner (R-OH) supports maintaining all of the tax cuts for 2013. He stated, “That’s why later on this month the House will vote to stop the coming tax hike to make sure that small business owners have some certainty about what the tax rates are going to be and hopefully we can begin to unleash them so they can begin to do what they do best – grow their businesses and expand jobs.” The House vote on extending all of the tax rates is scheduled for late July.
House Ways and Means Committee Chairman Dave Camp (R-MI) also expressed support for extending for one year all of the tax cuts. He noted, “House Republicans will vote this month to stop the tax hike on every American and create a path for tax reform that levels the playing field for the hard-working Americans in businesses trying to compete in a global economy.”
Editor’s Note: Your editor and this organization take no specific position on these comments by leaders in Washington. While there is no tax bill expected before the election, both parties are positioning for the negotiations in the November lame-duck session. The President will seek to raise taxes on upper-income persons. The Congressional Budget Office (CBO) has estimated that this tax increase would raise $71 billion per year. It is significant that Chairman Camp included the goal of creating a “fast-track” for tax reform as part of the bill. For any compromise that is negotiated in November, Chairman Camp and Sen. Baucus are likely to support a specific goal and schedule that will result in major tax reform in 2013.
AALU Urges Retention of Grantor Trusts
In a letter to Treasury Secretary Timothy Geithner, David Stertzer, the Chief Executive Officer of the Association for Advance Life Underwriting (AALU) discussed the White House estate and gift tax proposals.
Stertzer emphasized the importance of permanent and sustainable estate tax reform. He urged Geithner to create certainty for the estate planning process. He also discussed the White House proposal to change the rules on grantor trusts.
After commending the administration for proposing “fiscally sustainable” gift and estate exemptions, he hoped that the exemptions as passed this November would be made permanent. Stertzer also recommended retaining grantor trusts in their current form.
The traditional guidelines for grantor trusts have existed for multiple decades. It is possible to create an intentionally defective grantor trust (IDGT) and there is no gain or loss on sale of property from the grantor to that trust. While there is an initial gift and filing of an IRS Form 709 Gift Tax Return upon creating the trust, there are no gift taxes on further distributions from the trust to beneficiaries. Finally, if the grantor pays income tax on the trust income, that amount is not treated as a taxable gift.
The White House and Treasury have proposed changes to the grantor trust rules that would affect the IDGT. If the proposal is enacted, future grantor trust assets will be includable in the estate of the grantor at the date of death of value. Distributions during the grantor’s life to heirs would be subject to potential additional gift tax.
Stertzer observes that these proposed changes would be contrary to the goal of permanent and sustainable estate tax reform. The grantor trust is a “core component of most life insurance and estate plans.” In his view, the existing grantor trust law should be made permanent.
Because the Treasury Department estimates an increase in revenue of only $910 million over 10 years with the change in the grantor trust rules, Stertzer observes that this plan does not create “an environment that fosters tax avoidance.” Therefore, he suggests that the current grantor trust rules be retained in order to facilitate responsible long-term planning.
Editor’s Note: If this change is included in the November tax bill or in a major tax bill in 2013, it will have significant negative effect on the use of the IDGT strategy.
Applicable Federal Rate of 1.2% for July — Rev. Rul. 2012-20; 2012-27 IRB 1 (17 June 2012)
The IRS has announced the Applicable Federal Rate (AFR) for July of 2012. The AFR under Section 7520 for the month of July will be 1.2%. The rates for June of 1.2% or May of 1.6% 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.