Happy New Tax Year

January 3, 2006

The ball has dropped at Times Square and that can mean only one thing – the federal tax code has changed. Joseph Wallach, an accounting professor at UC-Riverside, has a nice summary of the new federal tax laws that went into effect on January 1. Here are some of the highlights, courtesy the San Bernardino County Sun:

Phase-out of personal exemptions is reduced. For taxpayers with higher incomes, it was possible to have all of your personal exemptions eliminated or phased out. Beginning in 2006, this personal exemption phase-out rule will be reduced by one-third, thus allowing greater personal exemptions for regular tax purposes.

Phase-out of itemized deductions is reduced. For taxpayers with higher incomes, it was possible to lose up to 80 percent of most of your itemized deductions. The itemized deduction phase-out will now be reduced by one-third resulting in the allowance of greater itemized deductions.

Estate-tax exemption at $2 million The estate-tax unified credit exemption equivalent is $2 million per person. Thus, a married California couple holding primarily community property valued at under $4 million would not have to pay a federal estate tax or a California estate tax. The top Federal estate-tax rate is reduced from 47 percent to 46 percent.

For a complete list, see the full story.

The highlight of the changes taking place is that the gradual phase-out of the phase-outs has begun, which was added to the 2001 tax cut package. These phase-outs were initially put in place under the 1991 Deficit Reduction Act (the famous bill in which former President Bush raised taxes) and were intended to limit the benefits that wealthier taxpayers could claim by itemizing their taxes, as well as when claiming exemptions. In tax circles, this became known as the PEP and Pease (named after former Representative Ron Pease (D-OH)).

While more revenue via a more progressive tax code was the intention, it was a terrible method to accomplish this goal, as it created even more complexity in the tax code and was a less reliable predictor of revenue. The best alternative would be to eliminate most of these deductions entirely and replace them with lower tax rates with possibly one standard deduction for everyone, thereby creating a tax code that is simple, stable, and efficient.


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