Tax reform is one of the major issues in the upcoming Presidential election, fueled by the conflicting goals of reducing the deficit and promoting economic growth. One such reform, which has been advocated by both President Obama and Governor Romney, among others, is to impose limitations on itemized deductions.
The interesting thing about this current controversy is that for the most part, itemized deductions have been limited as income increased until very recently. A main provision of Reagannomics under Ronald Reagan’s 1986 Tax Reform Act was the concept to lower rates, but as your income rose to limit the amounts you could deduct. Every administration since has had this basic tax policy – until George W. Under the Bush Tax Cuts (which we currently have), this Reagan commandment was broken in 2010. In 2010, yes after George W. was out of office, the Bush Tax Cuts eliminated the “phase out” of itemized deductions as your income grew. Congress and the Obama administration had an opportunity to change the law in late 2009, but opted to extend the Bush Tax Cuts until the end of 2012.
So where does that leave us?
It leaves us with no clear direction as to what will happen with tax rates and deduction in 2013 and beyond. I believe that we will return to more Reagan type tax policy, but time will tell. In the meantime, it is worth looking at some of the proposal that are before us.
- Mitt Romney (Gov. Romney) has informally proposed, as a possibility in his overall plan to broaden the tax base and reduce rates, capping income tax deductions. He initially mentioned a $17,000 cap (without specifying whether it would be for individual or married taxpayers), which he described as a “bucket” that taxpayers can “fill” however they please. However, during the first Presidential debate, he indicated a flexibility with the precise amount, saying that it could also be $25,000 or $50,000, and that deductions in excess of the cap would essentially “disappear for high-income people.
- President Obama has also repeatedly called for a cap on itemized deductions. For example, the Administration’s 2013 proposal would limit the benefit to certain higher-income taxpayers from itemized deductions, AGI exclusions, and certain above-the-line deductions (including pretax employee contributions to defined contribution plans and contributions to traditional IRAs) to 28% of the amount of the deduction or exclusion. This would effectively reduce the tax benefit from such items for taxpayers who are subject to marginal rates above 28%.
- Vice Presidential candidate Paul Ryan’s “2010 Roadmap for America’s Future” would have eliminated nearly all tax deductions and exclusions, and replaced them with increased standard deductions ($25,000 for marrieds filing jointly, $12,500 for single taxpayers). His more recent “Path to Prosperity” called for scaling back certain deductions and credits, but didn’t specifically identify which.
- The Fiscal Commission’s proposal would have eliminated itemized deductions, so that all individuals would take standard deductions only. It also would have permanently repealed the Pease limitation and replaced certain favored deductions (i.e., mortgage interest and charitable giving) with nonrefundable credits.
- The Simpson-Bowles plan contained two different individual income tax options. One option would eliminate nearly all tax expenditures and eliminate the phase-outs of itemized deductions. The second would restructure certain tax expenditures, including replacing the mortgage interest deduction with a 15% refundable credit, so that each retains approximately 80% of its current benefit. Each scenario would be accompanied with simplified and lower tax rates.
- The Bipartisan Policy Center’s Debt Reduction Task Force called for eliminating itemized deductions and the standard deduction, instead allowing all taxpayers to claim limited refundable credits for home mortgage interest and charitable contributions.
- The Wyden-Coats “Bipartisan Tax Fairness and Simplification Act of 2011” would have repealed certain itemized deductions and tax credits, and increased the standard deduction ($30,000 for marrieds filing jointly, $15,000 for single taxpayers). However, it would have retained the deductions for mortgage interest and charitable contributions. The plan would also have repealed the limit on itemized deductions.
Regardless of what Congress decides to do later this year, we believe itemized deductions will return to some limitation based on income. The form of these limits is yet to be determined.
We will keep you apprised of the pending tax reform as the year progresses. In the meantime, if you have any questions regarding our view of future tax policy, please do not hesitate to contact us.