A defining characteristic of an individual income tax system is its degree of progressivity. The United States has a rather progressive income tax. This means that the average tax rate paid by an individual increases as...
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- The Basics of Chairman Camp’s Tax Reform Plan
The Basics of Chairman Camp’s Tax Reform Plan
House Ways and Means Chairman Dave Camp (R-MI) released a plan today to reform the federal tax code. He set out with the goal of simplification while maintaining revenue neutrality. While his plan maintains revenue neutrality, on first blush it appears to do little by way of addressing the complexity of the tax code, and in some ways, makes the tax code more complex.
We’ll have more analysis on the plan soon – it will take us days to get through the 979 pages of legislative text – but in the meantime, here are the basics.
Individual Income Taxes
Tax Brackets Consolidated to Three Brackets with a Top Rate of 35 Percent
The plan consolidates the existing seven tax brackets down to three brackets of 10, 25, and 35 percent. The 10 percent rate would apply to individual filers with taxable income below $35,600 and joint filers with income below $71,200. On taxable income above those levels, taxpayers will pay a rate of 25 percent. The individual AMT is eliminated and the brackets remain indexed to inflation, but based on chained CPI.
The additional surtax of 10 percent (the third bracket with a rate of 35 percent) will be levied on certain income based on a modified definition of AGI (MAGI) for individual filers above $400,000 and joint filers above $450,000.
The MAGI measure is adjusted gross income minus charitable contributions and qualified domestic manufacturing income, plus multiple streams of income excluded or deducted from AGI under current law, including employer provided health benefits, the self-employment health deduction, foreign income, tax exempt interest, untaxed social security benefits, and currently excluded 401(k) contributions.
The standard deduction increases to $11,000 for an individual and $22,000 for joint filers. There is also an additional deduction of $5,500 for single taxpayers with at least one qualifying child, which begins to phase out at $30,000 of AGI.
It is worth noting that this proposal does not take any steps to eliminate the marriage penalty inherent in the rate structure.
Phase-Outs in Plan Create Additional Marginal Tax Rates
The proposal creates multiple implicit marginal tax rates due to multiple phase-outs and the income surtax. A major change would be the phase out of the 10 percent rate bracket for individual filers with income above $250,000 and joint filers with income above $300,000. In effect, this would phase in a tax claw back, where individual filers who make over $250,000 ($300,000 for joint filers) would face a 25 percent tax rate on all income below the 35 percent bracket on income over $400,000 for single, $450,000 for filing jointly.
The standard deduction and the child tax credit would face a phase-out as well. (Personal exemptions are eliminated, so no need for a phase-out there.) This would create new implicit marginal tax rates for taxpayers as their income increases and these provisions phase out.
The phase out for all of these provisions occur sequentially starting at $250,000 for singles and $300,000 for filing jointly, in this order: (1) the 10 percent bracket, (2) the standard deduction or equivalent amount of itemized deductions, and (3), the child tax credit.
Proposal Makes Significant Changes to Individual Tax Expenditures
Chairman Camp’s proposal makes changes to a significant number of individual tax expenditures. The lists below are not all inclusive. For a complete list, see the Ways and Means section by section summary.
- Eliminates the personal exemption
- Eliminates the Pease provision which limits itemized deductions
- Eliminates state and local tax deduction
- Eliminates the alternative minimum tax
- Eliminates deduction of interest on education loans.
- Eliminates adoption tax credit
- Eliminates credit for green energy residential improvements
- Eliminates credits for qualified electric vehicles and alternative motor vehicles
- Eliminates first time homebuyer credit
- Eliminates deduction for tax preparation expenses
- Eliminates deduction for medical expenses
- Eliminates deduction for moving expenses
- Reduces the principal cap for the home mortgage interest deduction from new mortgages from $1 million to $500,000 over four years.
- Reduces the maximum credits for the EITC to $200 for joint filers with no children, $2,400 with filers with one child, and $4,000 for joint filers with two or more children. For taxpayers with children, phase outs begin at $20,000 for single filers and $27,000 for joint filers.
- Converts some excludable 401(k) contributions to Roth-style retirement accounts for those contributing more than $8,750.
- Modifies allowable contributions to Roth IRAs, eliminating the income eligibility limit for contributors and prohibiting contributions to traditional IRAs.
- Consolidates the four higher education tax credits into a reformed American Opportunity Tax Credit. The new credit would provide a 100 percent credit on the first $2,000 of certain education expenses, and a 25 percent credit on the next $2,000 of expenses. The first $1,500 of the credit would be refundable.
- Expands the child tax credit from $1,000 per child to $1,500 per child and $500 for non-child dependents. Credits will be indexed to chained CPI.
- Increases in the standard deduction to $11,000 for an individual and $22,000 for joint filers, with an additional deduction of $5,500 per qualifying child.
Capital Gains and Dividend Taxes Increase from 23.8 Percent to 24.8 Percent
Under the plan, capital gains and dividends would be taxed at the ordinary rate with a 40 percent exclusion. This means, with a top rate of 35 percent, the top effective rate capital gains and dividend rate would be 21 percent. Add this to the 3.8 percent Affordable Care Act surtax, for a total of 24.8 percent. However, it’s likely taxpayers will face higher marginal rates due to the phase out of the standard deduction, child tax credit, and 10 percent bracket.
Lowers the Corporate Income Tax Rate
Today, the top federal corporate tax rate is 35 percent. Chairman Camp’s plan would lower the top marginal corporate income tax rate to 25 percent. The rate reduction will be phased in over 5 years from 2015 to 2019.
Lengthens Asset Lives, Changes Tax Treatment of R&D and Advertisement
One of the major changes to the corporate code is the way in which the code treats business investment. The proposal would eliminate the current modified accelerated cost recovery system (MACRS) and replace it with a system similar to the alternative depreciation system (ADS). This will lengthen asset lives, reduce the present value of capital cost write-offs, and boost taxable business income relative to current law.
However, to mitigate some of the damage a switch to a system like ADS creates, the basis of the depreciable assets would be adjusted for inflation.
The plan would also alter the way in which tax law treats research and development (R&D) and advertisement costs. Rather than allowing a business to fully expense most R&D expenses, the business will have to deduct these costs over 5 years. Likewise, advertising will no longer be completely deducted in the year in which the expense was incurred. Certain advertising costs will be 50 percent deductible in the first year and rest will be amortized over 10 years.
Tax Rates Lowered for Pass-Through Businesses to 35 percent, 25 Percent for Those Engaged in Manufacturing
More than 50 percent of business income is taxed through the individual income tax code. As a result, these “pass-through” businesses face top marginal tax rates as high as 39.6 percent on their income.
Chairman Camp’s proposal would reduce the top marginal income tax rate faced by pass-through businesses from 39.6 percent to 35 percent. However, domestic manufacturing pass-through income will be exempt from the 10 percent “surtax” on incomes over $400,000, meaning this income would only face a lower 25 percent rate.
A Shift to a Territorial System, with a Retroactive Tax on Foreign Earned Income
Currently, U.S. corporations are taxed on their worldwide income, but allowed to defer taxes on foreign income that remains actively invested abroad. When corporations earn income overseas and bring this income back to the United States, the United States taxes it at 35 percent, minus any foreign taxes paid on the income.
The Camp proposal would deem accumulated past foreign earnings currently held abroad in cash as repatriated and retroactively tax it once at an 8.75 percent rate. Remaining non-cash accumulated foreign earnings held abroad (income that has already been reinvested in property, plant, and equipment) would be retroactively taxed at a lower 3.5 percent rate. The corporation has the option to pay this tax over an eight year period.
Going forward, the United States would switch to a territorial corporate tax system, which would exempt from domestic corporate taxation 95 percent of all active foreign income. Look-through rules, which allow corporations to move money between foreign subsidiaries without triggering U.S. tax liability, would be made permanent. Subpart F will be modified so that intangible income (such as royalties) will be taxed at a 15 percent rate, whether it is earned domestically or abroad. This is similar to the "patent boxes" found in other countries. There will also be a "thin-cap" rule that limits deductions for interest expense based on the leverage of the U.S. parent relative to foreign subsidiaries.
New Excise Tax on Big Banks
The proposal introduces a .035 percent excise tax on banks that are deemed “important.” This tax will be levied quarterly on these banks’ total consolidated assets in excess of $500 billion beginning in 2015.
Businesses are currently allowed to choose one of two ways to account for the cost of inventory: Last-in, First-out (LIFO) and First-in, First-out (FIFO).
The proposal would repeal LIFO accounting. Existing corporate LIFO reserve would be added back into taxable income in four phases between 2018 and 2020, retroactively taxing this inventory.
Elimination of Many Energy Provisions
Under the Camp proposal, a number of credits and deductions for the oil and gas industry and green energy are repealed:
- Eliminates percentage depletion
- Eliminates credit for producing oil and gas from marginal wells
- Eliminates enhanced oil recovery credit
- Eliminates deduction for energy efficient commercial buildings
- Eliminates credit for alcohol used as fuel
- Eliminates credit for biodiesel and renewable diesel used as fuel
- Eliminates passive activity exception for working interests in oil and gas property
- Phases-out credit for electricity produced from certain renewable resources
- Eliminates credit for production of low sulfur diesel fuel
- Eliminates credit for production from advanced nuclear power facilities
- Eliminates credit for producing fuel from a nonconventional source
- Eliminates new energy efficient home credit
- Eliminates energy efficient appliance credit
- Eliminates credit for carbon dioxide sequestration
- Eliminates solar energy credit
Other Business Provisions
- Section 179 currently allows small businesses to expense up to $25,000 of the cost of qualifying property. The proposal would increase that amount to $250,000 and make it permanent.
- Section 199 manufacturing deduction allows businesses to deduct 9 percent of qualifying manufacturing expenses (6 percent for integrated oil and gas companies). This deduction is phased out completely.
- The Research and Development (R&D) tax credit gives businesses a tax credit for research and development expenses. The Proposal will make the R&D credit permanent while modifying how it is calculated.
- Disallows businesses from deducting the cost of executive bonuses if they are in stock and imposes a 25 percent excise tax on compensation over $1 million paid by non-profit, tax-exempt organizations.
- The Obamacare 2.3 percent excise tax on medical devices would be repealed.
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