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Allowing Taxpayers to Keep More of What They Earn Motivates Them

Allowing Taxpayers to Keep More of What They Earn Motivates Them
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Friday, 04 August 2017 09:01 AM Current | Bio | Archive

Tax reform should decrease the federal tax levy upon American taxpayers, simplify the Internal Revenue Code, and reduce the national debt.

Here are some ideas toward accomplishment of these objectives.

Across-the-Board Tax Cut

Our top federal income tax rate is 39.6 percent for individuals and 35 percent for corporations. Individuals are also subject to an additional federal tax equal to 3.8 percent of their net investment income. State taxes are in addition to the federal levy. Such tax rates are far too high.

Our liberty-minded founding fathers would roll over in their graves at the thought of the federal tax rates in our country today. We had no income tax at all until 1913. Our first income tax was at the top rate of 7 percent, with a high exemption that shielded all but 2 percent of households from the tax.

We need a substantial, across-the-board tax cut. Presidents Kennedy and Reagan proved that allowing taxpayers to keep more of what they earn motivates them to produce and earn more, increasing the tax base and hence federal revenues. Such a tax cut would make American companies more competitive internationally, and could motivate American corporations to repatriate earnings of their foreign subsidiaries.

Eliminate the Capital Gain Rate Differential

Net long-term capital gains are taxed at a maximum federal rate of 20 percent. Does it make sense to tax earnings from personal services—work—at a higher rate than gain from mere appreciation in value of held property?

Elimination of the capital gain rate differential is not a new idea. The National Commission on Fiscal Responsibility and Reform (“Simpson-Bowles”) proposed it in 2012. The idea is worthy of serious consideration now.

Repeal the Alternative Minimum Tax

Repeal of the alternative minimum tax is an important step in simplifying the federal tax code. The AMT is a complex tax regime which parallels the regular tax for individuals and corporations.

The AMT is also failing its essential purpose. Congress intended the AMT to assure that wealthy individuals pay their fair share of tax. The New York Times reports that in 2016, the AMT hit 30.3 percent of households with income of $200,000-$500,000, 62.9 percent of households with income of $500,000-$1,000,000, and only 20.5 percent of households with income above $1,000,000.

The National Taxpayer Advocate recommends repeal of the AMT. Repeal of the AMT has bipartisan Congressional support.

Repeal Depreciation Deduction for Real Property

No depreciation deduction is allowed for land. Arguably no depreciation deduction should be allowed for of improvements to real property—buildings, etc. Gain on sale of real property is recaptured as ordinary income upon sale of the real property. If no deduction were allowed for real property, the forgone depreciation deductions would decrease gain on sale of the property, or increase loss on sale of the property.

Depreciation deductions should continue to be allowed be allowed on machinery and equipment, however, as this is an important incentive for sales in the manufacturing sector.

Repeal Refundable Tax Credits

The IRS annually makes tens of billions of dollars in unlawful payments under refundable credit programs. Refundable credits are treated on tax returns as payments of tax to the government—the IRS refunds them to the claiming taxpayer to the extent they exceed the taxpayer’s tax liability. There are three such credits. The Earned Income Tax Credit (“EITC”) provides assistance to low income taxpayers. The Additional Child Tax Credit (“ACTC”) provides assistance to families caring for refugee children. The American Opportunity Tax Credit (“AOTC”) provides assistance for a taxpayer’s first four years of higher education.

The U.S. Treasury Department, in its Fiscal Year 2016 Financial Report, estimated that between 22.2 percent ($15.5 billion) and 25.9 percent ($18.1 billion) of the total EITC program payments of $69.8 billion were improper. The TIGTA estimated that, for FY 2015, the potential ACTC improper payment rate was 24.2 percent, with potential improper payments totaling $5.7 billion, and that the potential AOTC improper payment rate was 30.7 percent, with improper payments totaling $1.8 billion. U.S. Treasury and the IRS have consistently found that payment errors for EITC and other tax credit programs are attributable to the complexity of the credits within the tax system, and not rooted in internal control weaknesses, financial management deficiencies, or financial reporting failures. Eligibility rules are complex and lead to high overclaim rates for these credits.

For 2016, the maximum EITC is $3,373 for a single taxpayer with one qualifying child, $5,572 for a single taxpayer with two qualifying children, and $6,269 for a single taxpayer with three or more qualifying children.

A “qualifying child” is a child who meets a relationship test, an age test, a residency test, and a joint return test. The relationship test requires the child to be the taxpayer’s—

  • the son, daughter, stepchild, or foster child, or the descendant of any of them (for example, the taxpayer’s grandchild), or
     
  • brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them (for example, the taxpayer’s niece or nephew).

The age test requires that the child must be—

  • under age 19 at the end of the tax year and younger than the taxpayer (younger than the taxpayer and the taxpayer’s spouse, if they file a joint tax return),
     
  • under age 24 at the end of the tax year, a student, and younger than the taxpayer (younger than the taxpayer and the taxpayer’s spouse, if they file a joint tax return), or
     
  • permanently and totally disabled at any time during the tax year, regardless of age.

Under the residency test, the child must have lived with the taxpayer for more than one-half of the tax year.

The joint return test provides that the child cannot file a joint income tax return for the tax year.

Such specific, personal information on the millions of tax returns claiming EITC annually cannot possibly be verified by the IRS.

Refundable tax credits should be repealed. Having to dispense public assistance in furtherance of non-revenue social goals distracts the IRS from its critically important function as the revenue-collecting agency of the federal government. Moreover, the high overclaim rates of these credits causes tens of billions of dollars in unlawful payments to flow annually from the federal treasury. But repealing refundable credits would require political courage, a characteristic lacking in some quarters of late.

Stephen J. Dunn is a tax attorney in Troy, Michigan. He is the author of the treatise Foreign Accounts Compliance (Thomson Reuters 2017) and Foreign Accounts Compliance Blog.

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StephenJDunn
Tax reform should decrease the federal tax levy upon American taxpayers, simplify the Internal Revenue Code, and reduce the national debt.
tax, reform trump, debt
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2017-01-04
Friday, 04 August 2017 09:01 AM
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