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Camp Issues US Tax Reform Discussion Draft

by Mike Godfrey, Tax-News.com, Washington

28 February 2014


House of Representatives Ways and Means Committee Chairman Dave Camp (R – Michigan) has issued his long-awaited United States comprehensive income tax reform discussion draft, which proposes to reduce maximum tax rates and simplify the tax code over 182 pages of a section-by-section "summary."

Highlights of the revenue-neutral Tax Reform Act of 2014 include a new individual and corporate income tax rate structure. Using changes to individual and business tax breaks, it flattens the individual tax code by reducing rates and collapsing the current brackets into two of 10 percent (encompassing the present 10 percent and 15 percent bands) and 25 percent, "ensuring that over 99 percent of all taxpayers face maximum rates of 25 percent or less."

An increased standard deduction of USD11,000 for individuals and USD22,000 for married couples would result, according to the Joint Committee on Taxation (JCT), in nearly 95 percent of taxpayers not requiring to itemize their individual tax deductions.

The six different family tax benefits (basic standard deduction, additional standard deduction, personal exemptions for taxpayer and spouse, personal exemptions for dependents, child tax credits, and head of household filing status) would be assimilated into the larger standard deduction, an additional deduction for single parents, and an expanded child and dependent tax credit of USD1,500 per child and USD500 per dependent.

In addition, the highly complex Earned Income Tax Credit (EITC) would be simplified by converting it into an exemption of a certain amount of payroll taxes (both the employee and employer shares). Depending on household circumstances, families could be shielded from as much as USD4,000 in payroll tax liability. It is hoped that this would also eliminate the estimated USD133bn over 10 years in erroneous and fraudulent EITC payments.

The tax reform package would also allow up to USD8,750 (half of the contribution limit) to be contributed either to a traditional retirement account (where tax is paid when taking a pension) or a "Roth" account (where contributions are made after tax). Any contributions in excess of USD8,750 would be dedicated to a Roth-style account – making these savings tax-free during retirement.

There is no impact on future refinancing of existing mortgages. However, while current law caps the amount of mortgage interest that can be deducted to the first USD1m of mortgage debt. Beginning in 2015, for those taking out new mortgages, the plan would reduce the existing USD1m cap so that for mortgages taken out in 2018 or later, the cap would be USD500,000.

The reform package would also cancel the Alternative Minimum Tax (AMT) for individuals, pass-through businesses and corporations, while long-term capital gains and dividends would be taxed as ordinary income, with an exemption for the first 40 percent of such income from tax.

Of specific interest to those pass-through business owners paying individual income taxes, it is pointed out that nearly every small business would benefit from paying no more than a top tax rate of 25 percent; the double taxation of investment income being lowered to historic lows; the repeal of the AMT; simplified compliance through various reforms of business deductions and credits; permanent section 179 (full deduction on cost of qualifying equipment) expensing on as much as USD250,000 in capital investments each year, including real property; an expansion of the use of cash accounting for businesses with gross receipts of up to USD10m; and a maintenance of the current law on the estate tax.

Using the reform of a large number of business-related exclusions and deductions, the plan also reduces the maximum corporate tax rate from 35 percent to 25 percent on a gradual basis. For taxable years beginning in 2015, the maximum rate is 33 percent; for taxable years beginning in 2016, the maximum rate is 31 percent; for taxable years beginning in 2017, the maximum rate is 29 percent; and for taxable years beginning in 2018, the rate reduces to 25 percent.

It is notable that the corporate tax break changes include making the Research & Development Tax Credit permanent and improving its terms. The simplified research credit would be equal to 14 percent of qualified research expenses that exceed 50 percent of those expenses for the three preceding taxable years.

While, it is said, the plan generally leaves President Obama's Affordable Care Act tax measures "untouched and for a later debate on healthcare," it is proposed that the medical device tax would be repealed, as would the "medicine cabinet tax," which prohibits use of funds from tax-free accounts to purchase over-the-counter medication without first obtaining a prescription.

The package would also transform US international tax rules by replacing the current "worldwide" system with a "quasi-territorial" 95 percent dividend exemption for foreign business income. The exemption would apply to dividends paid by foreign companies to US corporate shareholders owning at least 10% of their shares, and no foreign tax credit would be allowed for any taxes paid or accrued with respect to any dividend for which the 95-percent deduction is allowed.

Thus, the effective US tax rate on most foreign dividends would be 1.25 percent (the new 25 percent rate multiplied by the 5 percent of income that is not exempt) – putting, it is considered, American companies on a more level playing field with foreign competitors. The proposal would also end the "lock-out effect" that discourages companies from bringing foreign earnings back to the US.

However, despite the comprehensiveness and detail put into his draft by Camp, it seems extremely unlikely that his plan will be considered this year by Congress. While the House Speaker John Boehner (R – Ohio) called it a "discussion draft" that will begin a "conversation" about the issues surrounding tax reform, Senate Minority Leader Mitch McConnell (R – Kentucky) was also skeptical that tax reform would pass, given the differences with the Democratic Party that would use it, against Republican wishes, to provide additional deficit-reducing revenue.

Nevertheless, as concluded by Hank Gutman, Director of KPMG's Federal Tax Legislative and Regulatory Services group in the firm's Washington National Tax practice and a former JCT chief of staff, "even if comprehensive tax reform does not advance this year, these proposals will create a context for debate and could serve as a template for subsequent reform efforts. Business leaders would be wise to take the time to understand these proposals, so that they can begin to assess their potential implications."

TAGS: individuals | capital gains tax (CGT) | tax | investment | small business | business | law | accounting | retirement | corporation tax | payroll | tax credits | legislation | tax rates | United States | tax breaks | dividends | tax reform | individual income tax | research and development | Tax

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