Limiting or reducing deductions were among the highlights of the most recent tax reform proposal on Capitol Hill, catapulting tax-preference items to the forefront of the debate once again.
Although unlikely to proceed as a formal piece of legislation, the Tax Reform Act of 2014 — released last week by House Ways and Means Committee Chairman David Camp — establishes a foundation for the ongoing tax discussion.
The proposal is similar to other plans, such as the Simpson-Bowles offering — calling for the streamlining of income tax brackets with a significant reduction in tax credits, exemptions, and deductions. The proposal addresses individual as well as corporate tax reform, the elimination of the alternative minimum tax (AMT), and other areas of the code such as the treatment of foreign income and tax-exempt entities.
Key provisions affecting individual taxpayers include:
- Reduction in tax brackets. The current seven tax brackets would be reduced to three — 10%, 25%, and 35%.
- No separate rate structure for dividends and capital gains, which would be taxed as ordinary income, with a 40% exclusion.
- Income above $400,000 ($450,000 for couples) would be subject to highest tax rate of 35%.
- Income subject to taxation for those in the top bracket is broadened to include formerly non-taxable items such as tax-exempt interest, employer health contributions, the exclusion for pretax retirement plan contributions, and the amount of Social Security benefits excluded from gross income.
- The standard deduction is increased from $6,200 ($12,400 for couples) to $11,000 ($22,000 for couples). Under this framework, the Joint Committee on Taxation estimates nearly all taxpayers would use the standard deduction instead of itemizing.
- The standard deduction is phased out at higher income levels — $358,750 for individuals, $517,500 for couples.
- Personal exemptions are eliminated.
- The deduction for mortgage interest (on new mortgages only) is gradually reduced from $1,000,000 in mortgage debt today to $500,000 over several years.
- Charitable contributions can only be deducted to the extent they exceed 2% of income.
- The deduction for medical expenses and miscellaneous 2% deductions are repealed.
- Many tax credits are repealed — including credits for dependent care, adoption, residential energy efficient property, and first-time homebuyers.
- No new contributions to Traditional IRAs.
- Income limits for Roth IRA contributions are eliminated and Roth recharacterization is eliminated.
- Employers would not be able to establish new SEP IRAs or SIMPLE 401(k) plans.
- Pretax employee deferrals into retirement plans are limited — after reaching $8,750, subsequent contributions must be made into a designated Roth account (retirement plans would generally be required to offer Roth accounts).
- The Stretch IRA option for non-spouse beneficiaries would be limited only to adults who are disabled, chronically ill, or not more than 10 years younger than the deceased, or to a child. All other non-spouse beneficiaries must withdraw funds within a five-year period following the account owner’s death.
- The option to utilize the net unrealized appreciation option on distributed company stock is eliminated.
- Certain tax benefits for higher education, such as the deduction for tuition payment are eliminated, while the American Opportunity Tax Credit is made permanent.
- Coverdell Savings Accounts are phased out, and the exclusion of U.S. savings bonds for college expenses is repealed, while there are no changes to the 529 college savings program.
The Tax Reform Act of 2014 was released as a proposal and not a bill. For more details, explore the full summary. Some of its provisions, however, may become part of future legislation. While the prospects for comprehensive tax reform may seem unlikely in the near term, some of the proposal may be implemented when the tax code is reformed in the future. The issue of tax reform is a key topic for advisors, as many of the proposals would affect their clients’ tax situation and planning strategies.
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