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Recent articles by Jeff Schnepper: • Why the tax system drives me -- and you -- crazy, 10/31/2005 • Let Uncle Sam help fund a retirement home, 10/30/2005 • Tax shelters still exist and can save you money, 10/27/2005 More... |
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| The Basics | |||
| At risk: your home-mortgage deduction | |||
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The president's tax panel proposes sweeping revisions that gore some sacred cows, including the mortgage-interest deduction. Savers and investors get some help. By Jeff Schnepper A limit on the mortgage deduction? Oh, my! A presidential tax reform panel would simplify your taxes by rewarding savings, dumping some deductions and limiting others -- like mortgage interest. Here's what's dead already and what ideas may have some traction. If youre an investor or a saver, happy days are here to come. However, you're going to be more responsible for your own health care, and housing will take a hit. That is, if President Bush's Advisory Panel on Federal Tax Reform's recommendations are enacted. The odds of all the recommendations becoming law are low, and for some provisions, the chances are nonexistent. But keep an eye on the panel's work, because it will become the basis of tax debate for the next two years. It could and probably will affect you.
The Bush tax panel has actually come up with two plans. There's a streamlined income tax system with lower rates that limits or eliminates most deductions and credits. The other would be a progressive consumption tax system that would still require everyone to file an annual return. It looks like the modified income tax is the panel's preferred choice.
Here's a rundown of the panel's big proposals -- and my assessment of whether any have a chance of moving into the tax code. Alternative minimum tax The panel recommended abolishing the dreaded alternative minimum tax (AMT). Created to force higher-income taxpayers with tax shelters and sophisticated deductions from completely avoiding contributing to our tax system, the AMT has now become a middle-class nightmare. Related news and commentary on MSN Money In June 2003, the Brookings Institution projected that 43% of taxpayers with incomes between $50,000 and $75,000, and 79% of those earning between $75,000 and $100,000 will be hit by the AMT. Schnepper's take: This ones a winner! But it raises an immediate and serious question: How is the government going make up the $1.2 trillion that the AMT is scheduled to generate over the next 10 years? Heres where the panel wants to get it: Mortgage interest deduction The McMansions are gonna go! Currently, you can deduct the interest paid on a principal home mortgage and on second-home mortgages up to a combined $1 million in loans, and then deduct the interest on another $100,000 in home-equity loans. The panel voted to lower the limit to the maximum mortgage the Federal Housing Administration would insure, which varies from county to county across the country. Currently, it's between $172,000 and $312,895; the average nationally is about $244,000. The levels change each year. The panel would also eliminate the deduction for interest payments on home-equity loans and second homes. Of course, there wouldn't really be a deduction at all. Instead, the panel would make home-mortgage interest payments eligible for a 15% credit. If youre in the more-than-15% bracket (2006 taxable income of more than $39,700 for singles and more than $59,400 on a joint return), this idea will hurt. A $5,000 qualified interest deduction in the 25% bracket saves you $1,250 in tax. A 15% credit only reduces your tax by $750. Youve just lost $500. If youre in the 10% bracket (2005 taxable income of less than $7,300 for singles and less than $14,600 on a joint return), the credit gives you a 5% bonus tax reduction over a deduction. Of course, if youre only making $14,600, youre not really in the market to buy a house. According to former Sen. Connie Mack, R-Fla., the panel chairman, Simplification has driven this. What?! Talk about complexity. Each county would have its own limit, different from the county next door. And both limits would change each year. Frankly, my dog can come up with a better idea! But, remember, they're looking for tax dollars to pay for cuts like elimination of the AMT. Schnepper's take: Aint gonna happen! At least not in the form presented. However, get ready. The mortgage-interest deduction is going to be limited. The panel understands that the size of the mortgage cap has helped push home prices to record levels in many markets. I wouldnt be surprised to see the $1 million cap on qualified borrowing cut to $300,000 to $500,000, with no deduction for interest on anything other than your principal residence. Think record federal deficits. Remember, theyre looking for money. State and local tax deduction The panel also is recommending eliminating the deduction for state and local taxes. Think red states vs. blue states. Remember panel chairman Connie Mack? Hes from Florida, where there is no state income tax. Blue states like New York and New Jersey wont be happy. In fact, their congressional delegations are already lobbying against the idea. Reason: Their constituents pay high state and local taxes and incur huge mortgages thanks to high home and apartment prices. If the mortgage-interest deduction is reduced and the state income-tax deduction is eliminated they'll be even more blue. Schnepper's take: Aint gonna happen! Theres no way politically that the blue states plus representatives from high-tax-and-home-price California will let this pass. Not if they want to be re-elected. Elimination of the deduction would raise taxes for an estimated 45 million taxpayers, with an average tax increase of $1,700. If you live in New York, on average it will cost you an additional $2,774. California homeowners would be hit with an average increase of $2,221. Health benefits Health benefits paid by employers for their employees are now tax free. This tax benefit is not nearly as visible as the mortgage deduction, but it is very valuable. The panel wants to tax employer-paid health-insurance premiums above $5,000 a year for singles and $11,500 for family policies. So, if your company paid premiums worth $14,000 for you and your family, you would pay tax on the excess over $11,500 -- or $2,500. Schnepper's take: This one has traction. Theres universal agreement that health-care costs have gotten out of hand and need to be reined in. One way to do this would be to limit the goodies. President Bushs Health Savings Accounts have already started to shift the focus from unlimited health-care access to individual responsibility. As a nation, we can no longer afford to finance a trip to the doctor every time you have a headache. Youre going to be more responsible for your own health care. More of it will be coming out of all our pockets. Charitable donations Today, you get no tax benefit from charitable contributions unless you itemize your deductions. The panel would let everyone deduct charitable donations, but only to the extent they exceed 1% of your adjusted gross income. If you take the standard deduction, youre a big winner here. If you already do itemize, this cuts the value of your deduction by 1% of your AGI. Schnepper's take: Another one with traction. Everybody wants to be able to deduct his favorite charitable donations. And, there are lots of voters who take the standard deduction whod rally behind this one. Savings and investing Heres where the two alternative plans differ:
Schnepper's take: Another winner! Theres no question as to who wins if any of the above provisions are passed -- investors, savers, those in the higher brackets and the American economy. Personally, I dont see any losers here. Tax rates and other provisions: Both plans shrink our current six tax brackets down to four. Rates would be 15%, 25%, 30% and 33% with the streamlined income tax. Under the progressive consumption tax, rates would be 15%, 25%, 30% and 35% on total income, less additions to savings. The panel wants to replace deductions with credits and reduce the so-called marriage penalty by providing a family credit of about $1,650 for singles and $3,300 for joint filers. It suggests increasing the current $500,000 gain exclusion on a sale of your principal residence to $600,000 and indexing that number for inflation. Remember, these are only recommendations. The final outcome is going to be determined by the give and take of political compromise over the next two years and possibly longer. (The 1986 tax reform law took more than two years to negotiate.) And, with Iraq and rebuilding at home after the past months natural disasters, tax code modifications -- especially the idea of a consumption tax -- arent going to be primary on the Congressional agenda for a while. But these ideas will come up and may well turn up in some legislation. So, keep an eye out. A final note: Several months ago in my column "7 big tax changes I'd really like to see," I asked for your ideas and your recommendations. There were more than 384 responses to the article. Thanks for all your replies and the insight they contained. Frankly, I doubt if this panel gave them much heed. Hopefully, before any of this becomes law, Congress will take a look. | |||
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