While an administration and Congress may differ on the tax proposals that they want to see passed, especially when each is controlled by a different political party, there often are some areas of agreement. In addition, certain provisions may become acceptable as tradeoffs. Still others make it into law due to issues that may spark widespread public attention.President Bush's tax proposals within his fiscal year 2008 budget - contained in the Treasury's general explanation of the administration's FY 2008 revenue proposals (a.k.a. the "Blue Book") - have something to fit each category.
Irrespective of their eventual fate, the revenue proposals as presented in the Blue Book must be taken seriously at this point, and given serious consideration in the formulation of current tax strategies. "What if" a particular proposal passes? How should that possibility change tax planning now? Here are some educated guesses.
PERMANENT RATE DECREASE
While passage of permanently lower tax rates is not a probable political reality this year, the rates don't fall back to pre-2001 levels until 2011 anyway. Yet 2011 is suddenly close enough to start considering those future tax rates in connection with installment sales, depreciation schedules and retirement payout elections. Capital market decisions are also beginning to be affected, as the end of the lower capital gains and dividends rates in 2011 gets closer.
One indirect "hit" soon facing many individual homeowners in connection with a higher capital gains rate is exceeding the $500,000/$250,000 capital gains exclusion on the sale of a principal residence. Especially now that individuals are considering homeownership as a vital part of their retirement nest egg, a decision to sell sooner rather than later may start being more of a critical issue. The administration has no proposal to lessen that impact.
Hurrying to structure the sales of long-term capital assets to take advantage of the 0 percent tax rate that starts next year has suddenly taken off lately among tax planners, with a response by Congress to close the "loophole." Despite a child's reaching age 18, the new age at which the "Kiddie Tax" ends, the zero capital gains rate available to those within the 10 percent income tax bracket would not be available under proposed legislation if the child remains a dependent.
Use by older graduate students, elderly parents and other family members, however, will probably escape any legislative "fix." Nevertheless, in planning to maximize the current lower rates on capital gains, this new wrinkle should be watched, especially since it would provide revenue to allow the addition of an offsetting tax break or two.
The main criticism that the administration continues to level against current tax-deferred retirement savings vehicles in a proposal repeated for several years is that the present collection of multiple plans creates confusion. The administration wants only two accounts to keep things simple: the Retirement Savings Account and the Lifetime Savings Account.
RSAs would consolidate the current traditional, nondeductible and Roth collection of IRAs, but would restrict withdrawals to retirement needs. Lifetime Savings Accounts, however, would fill in and provide non-deductible, tax-free savings for any purpose, including retirement savings, health care, emergencies and education.
Contribution limits to RSAs would be $5,000 per year with no income limits but, similar to present Roth accounts, RSAs would not be deductible. Existing Roths would be automatically converted to RSAs. Existing traditional and nondeductible IRAs would be frozen, with an option to convert them to RSAs before 2009 and ratably include conversion income over the next four years. Those who are now thinking about converting existing traditional IRAs to Roths, therefore, might consider whether it makes sense to wait until 2009 to be able to income average over four years.
Contribution limits to LSAs would be $2,000 per year, regardless of wage income. Those accounts, however, would not be allowed to be converted from regular IRAs, suddenly locking funds now available for emergencies in IRAs into RSAs, unless the IRA account owner decides to freeze their IRA and have that amount subject to current withdrawal standards. Existing education savings accounts and qualified tuition plans would be allowed tax-free conversions to LSAs up to $50,000, but in order to prevent gaining an immediate advantage now, would also be limited to account balances as of Dec. 31, 2006.
On the qualified plan front, the administration proposed to combine 401(k), 457, 403(b) and simple plans into a single ERSA account, creating simplified plans that are easier to administer, and under which certain nondiscrimination and safe-harbor testing would be eased. Some employers presently without plans may want to watch this development before committing to a qualified plan with more rigorous requirements.
The proposed standard deduction for medical insurance has already caused a stir. Win or lose, however, the proposal is not set to begin until 2009, making for limited planning opportunities now in 2007.
Taking care of gold-plated out-of-pocket services and expensive medical-purpose equipment now, since there would no longer be an itemized medical deduction for such expenses, might make sense if moving forward with those treatments now or later is optional. Those employers setting up health plans may want to wait to save duplicate set-up costs later.
The use of high-deductible plans paired with health savings accounts, however, will continue to be encouraged by the administration, so that opting for that combination of health coverage now will be a safe bet against being forced to revise benefits anytime soon.
Taxpayers may not feel as much pressure to complete certain charitable contributions by the end of 2007 if two administration proposals are approved. The ability to give IRA assets up to $100,000 to charity by those over 70-1/2 income tax-free would be made permanent, rather than end in 2007. This provides a tax-favored way of giving away required minimum distributions and lowering adjusted gross income.
Second, the administration recommends making permanent the special percentage limits and carryover rules in favor of conservation contributions, giving some potential donors more time to consider their options before making this permanent covenant on their property.
The administration would make permanent the $250 above-the-line classroom deduction for out-of-pocket costs borne by teachers and administrators. Under current law, this deduction only runs through 2007.
With permanency, schools would be more apt to take the time to create verification forms that, in turn, would facilitate taking the deduction. Since it is calculated for the tax year (although being "full-time" is measured by the school year), however, excess expenses paid for in the fall of 2007 cannot be carried over to 2008.
SMALL BUSINESS EXPENSING
Section 179 expensing, which is scheduled to expire at the end of 2010, would be doubled starting next year to $200,000 annually, with an $800,000 phase-out, and would be made permanent. The decision to postpone purchases over the $100,000 mark ($112,000 with this year's inflation adjustment) because more will be deductible in 2008 will become easier to make as the year's legislative agenda develops and reality sets in.
One of the more certain bets for passage among the proposals is to be made on those that raise revenue. Billed as part of an overall strategy to reduce the tax gap, the administration's 2008 budget contains a number of proposals to increase tax compliance through expanded information reporting. They include:
* Requiring basis reporting on securities sales;
* Expanding broker information reporting on sales of tangible personal property;
* Requiring information reporting on merchant payment card reimbursements;
* Requiring information reporting on payments to corporations;
* Requiring a certified taxpayer identification number from contractors;
* Requiring increased information reporting for certain government payments for property and services; and,
* Increasing information return penalties.
Over the past year, much discussion has taken place over the need to have basis information reporting and holding period information reporting for securities sales on established markets. Already contained in a bill introduced in Congress last year, the administration's proposal would require brokers to maintain records of the adjusted basis of securities sold by their customers and report this information to the Internal Revenue Service. Under current law, sales proceeds are reported, but no information is provided about basis.
Basis reporting would begin for any securities acquired after Dec. 31, 2008. Many issues, such as dividend reinvestment plans and mutual fund reporting options, must be ironed out, but many believe that the revenue estimate to be gained - at least $6.7 billion over the next 10 years - is too tempting for Congress to resist in this pay-go environment. Current questions impacting planning include whether the 2009 effective date will cover stock splits acquired after 2009 or gifts of securities made after 2008.
The extenders that caused so much trouble at the end of last year, with their spillover impact on the current tax season, continue to demand attention. The administration proposes that some temporary provisions become permanent and some continue on a temporary basis. Three "extenders" are particularly notable for planning:
* A one-year individual alternative minimum tax patch by extending and inflation-adjusting the AMT exemption levels for 2007 to enable the number of individuals subject to AMT in 2007 to only be about the same as in 2006 - approximately 4 million taxpayers. While promises are being made to look into permanent reform, the more reasonable prediction for planning purposes is for more of the same, a "temporary patch," to continue into 2008.
* Making the research and experimentation credit permanent, which will enable many more companies to make a long-term investment commitment to research, knowing that the tax benefits won't end in midstream.
* Extending the Work Opportunity Tax Credit for one more year, through 2008, to employers for qualified wages paid to eligible group employees who begin work in 2008. This assurance of another year of the WOTC opportunity will allow businesses to plan workforce needs and budgets more accurately, which is especially important as 2007 moves forward.
Over the years, some of an administration's tax proposals as presented in its annual Blue Book become law ... and some do not. In any case, each year's Blue Book should not be dismissed when planning tax strategies, which necessarily address future events.
2007 should be an interesting year from that perspective, with more proposals that must stand on their merits, rather than their political backing, given a Republican administration and a Democrat Congress. Within those considerations, and especially on the revenue enhancement side of the ledger, a sizeable group of provisions this year should be taken seriously and anticipated as possibilities in the formulation of any tax strategy initiated in 2007.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a WoltersKluwer business.
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