[IMGCAP(1)]Tax reform, if it happens in the next two years, will occur in incremental steps rather than as a comprehensive package.
That’s the opinion of Carol Markman, CPA, director of taxation for Bryn Mawr, Penn.-based EP Caine & Associates CPA LLC. Markman, a past national president of the National Conference of CPA Practitioners (NCCPAP), testified earlier this week at the Senate Finance Committee Hearing on “Tax Complexity, Compliance, and Administration: The Merits of Simplification in Tax Reform.”
This was the third hearing the committee has had under chairman Orrin Hatch, R-Utah, to explore the principles of efficiency, fairness and simplicity.
“We have held hearings on the importance of growth and efficiency, and of fairness, in tax reform,” said Hatch. “Today we will discuss the problem of complexity in the tax code and the merits of simplification.”
“Simplicity is a lofty goal in tax reform that many of us would like to see,” responded Markman, the first witness. “However, simplicity frequently leads to unfair and/or unreasonable outcomes,” she said. “For example, the simplest type of tax is a sales tax but it is the most regressive type of tax since it places the highest proportionate burden on those least able to pay the tax.”
Markman listed five areas that, she said, “cry out for simplification”: retirement plans; education incentives; definitions in the code, in particular modified adjusted gross income; allowable mileage rates; and different forms of business entities.
Markman noted that there are 15 types of retirement plans listed on the IRS Web site, and that many taxpayers have more than one type of plan when they reach age 70½. “This age is important because at 70½ taxpayers must begin taking an annual required minimum distribution (RMD) from all of their retirement plans except if they are currently employed by the organization that is the sponsor of the plan or their account is a Roth IRA,” she said.
[IMGCAP(2)]An area ripe for simplification is the rule requiring a taxpayer to withdraw an RMD from each type of retirement account, according to Markman.
“Once the IRA owner calculates the RMD for each IRA that he or she owns, the IRA owner can withdraw the total amount from one or more of the IRAs,” she said. “Similarly, a 403(b) contract owner must separately calculate the RMD for each 403(b) contract that he or she owns, but can take the total amount form one or more of the 403(b) contracts. However, RMDs from other types of retirement plans, such as 401(k) and 457(b) plans, have to be taken separately from each of those types of plan accounts.”
“This begs the question: Why is it necessary to take an RMD from each type of retirement account?” she asked. “A taxpayer may have a small 457(b) and a large IRA. Perhaps they would like to take the RMD from the entire balance of the small 457(b) and the balance, if any, from the IRA account.”
A change that would allow this creates simplification with no reduction in tax revenue, she explained.
Another issue in retirement plans, the 10 percent penalty for early withdrawals, has 12 different exceptions, she observed. She recommended that the penalty exceptions to the additional tax on early distributions from retirement plans be made uniform across all types of plans.
Markman cited the numerous incentives in the code to encourage post-secondary education, noting that many of the incentives have different income phase-outs, limits on the number of years the benefit is available, the number of courses the student must take, and what type of expenses qualify for the incentive.
“There is a need to coordinate the various education incentives so that the benefits are available to the desired taxpayers with less confusion,” she said. “Fewer tax provisions with fewer phase-outs, per-family limits, and types of allowable expenses would go a long way to simplifying these provisions. A computer should not be needed to determine which education benefits apply and which ones provide the best tax result for a taxpayer.”
Among the many terms used in the code with varying definitions is Modified Adjusted Gross Income. MAGI is determined by adding back certain items to the individual’s Adjusted Gross Income.
“The difficulty is determining which items of income or deductions are added back,” she said. “This varies with the provision in the tax code for which MAGI is being calculated.”
Markman identified 17 add-backs and two subtractions that are needed for one or more MAGI calculations, including those to determine education benefits, who is allowed to make certain types of IRA contributions, the special allowance for real estate professionals, whether a taxpayer has to pay higher Medicare Part B and Part D premiums, the ACA Premium Tax Credit and the Health Coverage Exemptions.
“These varying definitions greatly add to the complexity of tax return preparation so that it requires a computer to calculate MAGI in many instances,” Markman stated. “It would aid in simplification if MAGI for similar provisions could be made uniform.”
Allowable mileage rates are another area that cries out for simplification, according to Markman. While there are several allowable mileage rates available to taxpayers for claiming deductions in connection with different types of travel, all except the charity rate are annually set by the IRS.
“The charity rate was set by the Congress prior to 1984 and has not been changed since that time,” she said.
Currently, the charity rate is 14 cents per mile, compared to 23 cents per mile for medical and moving, and the business mileage rate of 57.5 cents per mile.
“It does not make economic sense that the rate for charitable activities has not increased in 30 years,” she said. “Today, that rate is significantly lower than the rate for moving and medical care. Taxpayers view this difference as unfair since many more people can claim mileage for charity than can claim mileage for medical care.”
Markman suggested, “In the interest of simplicity and fairness, there should be one type of flow-through entity where the owners enjoy the same benefits.”
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