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Rangel Introduces Tax Reduction and Reform Act

by Leroy Baker,, New York

29 October 2007

US Representative Charles Rangel, the New York Democrat in charge of the House Ways and Means Committee, has introduced wide-ranging tax legislation into the House that proposes to deliver tax cuts for millions of Americans, while cutting taxes for US business. The bill also tackles the controversial issue of investment funds' carried interest.

Rangel announced on Thursday that his Tax Reduction and Reform Act of 2007 would be the most comprehensive reform of the US tax code since the Tax Reform Act of 1986, and would provide tax relief to more than 90 million working families through a permanent repeal of the individual alternative minimum tax (AMT), enhancement of other tax benefits, and a cut in the headline US corporate tax rate by almost 5%.

Rangel's bill also provides for a refundable child tax credit, an increase in the standard deduction, enhanced earned income tax credit, a one year patch to the AMT system for 2007, and extension of popular tax credits that expire at the end of the year. These provisions will be extracted from the larger bill in the coming weeks for expedited consideration before the Congress, he stated.

"For too long, hardworking families have struggled to keep pace with the rising cost of living in America. This legislation would put money back in their pockets to combat the growing economic insecurity gripping our nation," Rangel commented.

"The provisions in this bill would reform the tax code to provide a greater sense of equity and fairness that is so critical to our voluntary tax system," he continued. "It has been more than 21 years since Congress and the Administration rolled up their sleeves to discuss tax reform and during that time the tax code has become a jumbled mess of outdated and inequitable provisions that cry out for simplification. The package I proposed today is entirely revenue-neutral to ensure that the tax cuts we provide are not paid for by future generations or through reckless borrowing as has been the case in recent years."

The bill includes a significant reduction in the top corporate marginal tax rate to 30.5% from the current 35% level, and would permanently extend the current enhanced expensing rules that help small businesses compete. However, as ever, the devil is in the detail, and the legislation would also curtail certain corporate tax benefits in order to offset the cost of the tax cuts. These include the repeal of the domestic production activities deduction, the repeal of the worldwide allocation of interest, the limitation of treaty benefits for certain deductible payments, and the requirement that US corporations which defer income through controlled foreign corporations also defer the deductions that are associated with this income.

A controversial provision that is bound to provoke the ire of the private equity and hedge fund industry is a change in the tax treatment of "carried interest" for fund managers, so that they will no longer receive the lower 15% capital gains tax rate for what is, according to Rangel, "essentially a management fee or payment for services, which generally are taxed as ordinary income". The bill would, however, continue to tax carried interest at capital gains tax rates to the extent that carried interest reflects a "reasonable return" on invested capital.

These is also more bad news for hedge fund managers in the legislation, in the shape of curbs on hedge fund managers using offshore corporations and other structures to defer taxes on compensation received for providing investment services. For tax-exempt entities such as pension funds and university endowments, that invest directly in hedge funds, unrelated business income tax (UBIT) will be abolished, but this measure is designed to eliminate the incentive for exempt entities to invest in hedge funds and other investment funds through offshore “blocker” corporations.

Rangel claims that the Tax Reduction and Reform Act of 2007 is entirely revenue neutral, and is offset in large part by limiting the benefits of AMT repeal for taxpayers on incomes of more than $200,000 per year. However, the Ways and Means Chairman stated that an "overwhelming percentage" of families earning between $200,000 and $400,000 and "virtually all" families with income of less than $500,000 will still receive a net tax cut, since they will no longer have to pay the AMT. These taxpayers will instead pay an AMT "replacement tax" at 4% on incomes above $200,000, and 4.6% on incomes above $500,000 ($250,000 in the case of single taxpayers).

High income taxpayers will also be subject to overall limitation on itemized deductions, and phase-out of deductions for personal exemptions.

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