If it will take something dramatic to trigger a real debate about tax reform, yesterday's conference agreement on the tax reconciliation bill (H.R. 4297) may be a step forward for tax reform, in its own perverse way. So many important tax provisions will expire during the next president's first term that the tax law will look drastically different if no action is taken. Our lawmakers will have a chance to choose between dramatic changes by default and dramatic changes for a purpose.
Unfortunately, they'll probably just kick the can by extending things another year or two.
THE BIG ISSUES: NO SURPRISES HERE
The big items - dividend and capital gain rates, Section 179 expensing, and temporary alternative minimum tax relief, went as expected:
-The 15% rate for capital gains will expire after 2010, instead of 2008.
-The $108,000 limit on the Section 179 deduction (expensing items that would otherwise have to be depreciated) will revert to $25,000 for 2010, instead of 2008.
-The AMT exclusion amount will be increased for joint filers to $62,550 for 2006; it had been set to revert to $45,000 this year, throwing millions of additional taxpayers onto the AMT rolls.
While the main points of the bill weren't surprising, a few of the details were. These include:
SECTION 199 SURPRISES
-A restriction of the "W-2 wage limit" of the Section 199 "production deduction." The Section 199 deduction gives manufacturers and farmers a free deduction of 3% of their "domestic production taxable income." This deduction is limited to 50% of a taxpayer's W-2 wages. The new law reduces the restriction to 50% of W-2 wages "allocable to domestic production gross receipts." This will be a nasty surprise to some folks, particularly those with highly-automated manufacturing operations.
-The bill also "simplifies" the way W-2 wages pass-through for computing the Section 199 deduction. It repeals the old provision that limits the pass-through of W-2 wages to the amount needed to cover the production deduction on that K-1. This appears to enable taxpayers to use W-2 wages from one entity to enable deductions passing through from another entity under the 50% of W-2 wages limit. This may come in very handy...
TRADE SUBSIDY SURPRISE
-The bill yanks the "binding contract" relief for the illegal Foreign Sales Corporation and ETI trade subsidies otherwise repealed in 2004. This is to ward off renewed WTO trade sanctions over these rules.
CYNICAL REVENUE RAISERS
Taxwriters routinely use accounting sleight-of-hand that would make Andy Fastow blush, and this bill is no exception. The bill is full of tricks to manipulate income between years to meet budget limits -- no matter how silly the tax policy.
Roth IRA Conversions. The bill allows anybody to convert their IRAs to Roth IRAs in a taxable transaction. This privilege was formerly unavailable to taxpayers with AGIs over $100,000. This is designed to encourage taxpayers to pay taxes now in exchange for tax-free withdrawals in the future. This helps the current Congress with its revenue problems by increasing the revenue problems of their successors.
Cynical or not, this will provide a real opportunty for wealthy families. Roth IRAs have no minimum distribution requirements, and this will enable families to turn IRAs into multi-generation tax shelters at the price of current tax.
Corporate estimated tax games. They couldn't possibly have done this one with a straight face. C corporations with $1 billion or more in assets will deal with bizarre estimated tax requirements in 2006, 2012 and 2013:
- The 2006 estimated tax payment installments due in July, August or September (third quarter, for calendar year taxpayers) will be 105% of the amount otherwise due for the quarter. The same installment in 2012 will be 106.25% of the amount otherwise due; in 2013, the magic number will be 100.75% of the amount otherwise due.
-In 2010, 20.5% of the third quarter installment due September 15 will be payable October 1; in 2011, 27.5% of the third quarter installment is payable in October.
The government has a September 30 fiscal year, and these rules obviously shuffle income among the fiscal years to meet some arcane budget rule, at least on paper and in a laughably phony manner.
STRAIGHT REVENUE RAISERS
Extended Childhood: The bill increases the maximum age for the "kiddie tax," which taxes investment income of children at the parents' tax rate, to 17, from the current 13, effective this year. My 14 year-old will be thrilled.
Payments for offers in compromise. Underwater taxpayers who are trying to settle with IRS for pennies on the dollar will have to pay 20% of any lump-sum compromise offer before the IRS will consider it. Payers looking to negotiate an installment agreement will have to prepay the first proposed installment.
Withholding on government payments. The bill imposes a 3% withholding an all payments by federal, state or local governments that make over $100 million of such payments annually. This is either a reaction to revelations of tax-scofflaws with government contracts or a cynical ploy to pad out-year revenues that will never actually take effect. Given that it first will apply in 2011, "cynical ploy" is at least a reasonable surmise.
Penalty tax on tax-exempt entities that facilitate tax shelters. Many of the tax shelters of the 1990s were attempts to shift tax to complaisant tax-exempt entities. This bill creates a special tax to make that impossible. The TaxProf discusses this provision here.
Tin-Pan Lobby: How can I leave out my very favorite provision: capital gain treatment for songwriters who sell their work? While authors and artists - and you and me, for that matter - have ordinary income when we sell our work, songwriters will be eligible for capital gain treatment Who knew Tin-Pan Alley had such a lobbyist?
Most of the other provisions in the bill are fairly arcane. Some provisions that I had hoped for, such as the loosening of the strange Section 1375 tax on "net passive income" of S corporations, didn't make the cut. Eager lobbyists disappointed in this round still have hope, though, because the conference negotiators will soon hatch a separate "extenders" bill as part of their budget deal. The extenders bill renews perennially-expiring provisions like the research credit and the work opportunity credit for another year; it is a traditional Christmas tree for lobbyists.
Links (some pdf):
The TaxProf has a roundup of big-media coverage of the bill.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to