Tax Simplification Shouldn’t Be An Oxymoron
William E. Philbrick, CPA, MST, CVA
At more than 3,000 pages of small print, the Federal Tax Code is becoming longer and scarier than the collected works of Stephen King. Regardless of length, the tax code is appropriately named, as many sections are written in a code that only a seasoned professional can understand.
Simplification has been talked about since 1919 and was widely discussed in 1986, when the tax code was less than half its current length. Like all tax laws, the new Jobs and Growth Tax Relief Reconciliation Act of 2003 adds to the complexity of the tax code.
One reason the tax code has become so complex is that tax legislation requires compromise to be approved by Congress. Pressure from special interest groups, attempts at social engineering and other factors lead both parties to weigh down new tax laws with enough amendments to obscure the original intentions of the legislation.
Budgetary considerations also add to the complexity. To limit the cost of the new tax law to $350 billion, Congress set some provisions of the law to expire at the end of 2005. Similarly, provisions of the last major tax law, the Economic Growth and Tax Relief Reconciliation Act of 2001, are set to expire at the end of 2010.
Sunset provisions create inequities and make tax planning as difficult as predicting New England weather. For example, heirs of individuals with large estates could escape federal estate taxes if their benefactor dies in 2010, but they could be subject to estate taxes of up to 50% (after a credit for $1 million in asset value) if their benefactor dies in 2011.
Sometimes provisions of the tax code lie dormant and create chaos for future generations. The most egregious example is the alternative minimum tax (AMT), which was created in 1969 to ensure that wealthy taxpayers could not use shelters and deductions to avoid paying their fair share of taxes.
Each time a tax cut is enacted, more taxpayers are subject to the AMT. Even though the latest tax bill increased the AMT exemption, millions of taxpayers must now complete an AMT tax form just to determine whether they are subject to the tax.
It is not an easy form to complete. Depending on whether you are subject to the AMT, reading the instructions for filling out the form will either put you to sleep or keep you up at night. Simply calculating AMT income requires the taxpayer to consider 27 different deductions and sources of income, such as net operating loss deductions, 42% of qualified small business stock (why 42%?), income from incentive stock options, and the sale of property.
Take out a home equity loan to buy a boat and a portion of your mortgage payments become "interest from a home mortgage not used to buy, build or improve your home," which makes them subject to the AMT. Even state and local tax payments must be included when calculating AMT income, as if taxpayers were paying state and local taxes to avoid paying federal taxes.
It took the Joint Committee on Taxation 602 pages to summarize recommendations for simplifying the tax code. We don’t have that much space, but believe the following would be a good start:
- Eliminate the AMT. The AMT has outlived its usefulness and, because it is not adjusted for inflation, it is increasingly affecting middle-class taxpayers
- Eliminate phase-outs. The tax code includes more than 20 provisions that phase-out deductions, credits and other tax benefits for taxpayers who exceed income limits. The phase-outs use different definitions of income and, with one exception, each phase-out uses a different income range.
- Adopt a single definition for a "qualifying child." A qualifying child is defined differently for the dependency exemption, the earned-income credit, the child credit, the dependent care credit and head-of-household filing status. For example, to qualify for the child tax credit, the taxpayer’s child must be under 17; the taxpayer may file as "married filing separately." To qualify for the child-care credit, the taxpayer’s child must be under 13 or disabled; the taxpayer may not file as "married filing separately."
- Eliminate sunset provisions. Temporary changes in the tax law are inherently inequitable and are not worth making.
Congress should be able to agree on commonsense changes such as these, which would make the tax code not only simpler, but fairer. Tax simplification shouldn’t be an oxymoron.
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William E. Philbrick, CPA, MST, CVA is a Senior Vice President and Tax Director at Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached atwphilbrick@GRK&B.com.