IRA Contribution by April 15 May Prevent Paying Back Premium Tax Credit

The Premium Tax Credit (PTC) for individuals who purchased health insurance on the Exchange (Marketplace) is an important tax break.  As income goes up, this subsidy in the form of a refundable credit decreases. Then, it hits a cliff and completely disappears if one's household income exceeds 400% of the Federal poverty line (FPL). This can result in a tax bill of thousands of dollars!

Here is an example. A married couple, both age 64, thought their 2014 income would be about $62,000. Being eligible for insurance on the Exchange, they purchased a policy and obtained a PTC of $14,112. When they file their return, they realize they actually have $63,000 of income for 2014. this is above 400% of the FPL so they must repay all of the $14,112 PTC!  If they can drop their income to $62,040 (400% of the FPL for 2014), they don't have to repay the $14,112 (which they already used to be able to buy the insurance so no longer have). If they are eligible for an IRA deduction, and make a contribution of at least $960 (let's say $1,000 for safety) by April 15, they have engaged in some terrific tax planning (click here for IRS info on an IRA contribution by April 15). If they paid someone to prepare their return and that preparer was astute enough to give this advice - and the couple gets their return completed and filed in time to get the IRA contribution made on April 15, great for everyone. [Note: I used a 64 year old couple to generate a high PTC - health insurance costs more when you are older. See this 12/31/14 post.]

Given how the Administration wants to promote retirement savings, I'm puzzled why the IRA contribution idea wasn't built into the Form 8962 for the PTC.

This cliff is bad tax policy for the reason noted above AND because it makes the law inequitable. If this couple instead had employer-provided health insurance and the employer paid all or part of the cost of coverage, that benefit would not be taxable to the couple regardless of their income level.

What do you think?

Book recommendation - Geezer Rap

I recently read a short book in which the author, Douglas Lowe, ties the current inequality challenge to tax policy as it has evolved over the past 40 years. The author, suggests a pathway to tax reform through a novel re-framing of the tax debate. Titled "Geezer Rap," this one hour read is available from Amazon HERE (at a very low price). Mr. Lowe, a concerned citizen, raises important issues and ideas that should be part of the tax reform debate. I think his essay provides another perspective for thinking about tax rules and our tax system in a new ways that can help broaden and expand the necessary discussion on how our tax system needs to align with and support our economic, societal and environmental goals.

Take a look - what do you think?

Tax reform and the mortgage interest deduction

A "review and outlook" article in the 8/21/12 Wall Street Journal - "Tax Reform Skirmish" points out an event that may indicate some possibility of comprehensive tax reform in the near future. The paper reports that drafters of the Republican Party platform did not act on the request of the real estate lobby to protect the mortgage interest deduction. Per the paper, the drafters "managed to beat back an attempt by the real-estate lobby to put an endorsement of the mortgage-interest deduction into the 2012 Republican Party platform."

The mortgage interest deduction is in the top three of "tax expenditures" in terms of cost - about $90 billion per year. That is a lot of money!  It is a lot of money in terms of the few people who benefit from it.  The deduction is only claimed by those who itemized.  Only about 1/3 of individuals itemize their deductions and not all of them have mortgage interest.

The deduction is an upside-down subsidy because the higher your tax bracket (and your income), the more tax savings the deduction produces. Addition inequitable aspects of the deduction is that it also allows an interest deduction for a mortgage on your vacation home (not something everyone can even afford a downpayment for). And, if you have equity in your home, you can borrow up to $100,000 and deduct the interest (but not for AMT purposes). That's a much better deal then borrowing on your credit cards or getting a personal loan where the interest is not deductible.

And - research shows that the deduction doesn't even improve home ownership.  Home ownership rates in the US are about the same as in countries without these subsidies.

The WSJ notes: "As an economic matter, the mortgage deduction has long done more harm than good, misallocating capital to housing at the expense of other industries that might create more national wealth. The economy would be stronger, and might have avoided the trauma of the last five years, if housing demand hadn't been artificially inflated by years of policy favoritism."

That's right - the deduction lowers the tax rate on investment in homes, so we overinvest.

To keep lower tax rates, remove inequities, remove economic distortions, simplify the law and reduce the debt and deficit, I recommend:

1. Phase-out the home equity interest deduction over 5 years.
2. Phase-out the deduction for interest on a vacation home over 5 years.
3. Phase-out the $1 million debt limit on acquisition debt over 5 years. Drop it to $500,000 adjusted annually for inflation.
4. Convert the deduction to a tax credit.

Some will argue that it will hinder the housing market.  But, it may just bring it into equivalent treatment to other types of investments.  Also, it frees up money that could be used to provide assistance for low-income individuals to purchase a home.

For research from the Tax Policy Center that points out problems with the deduction, click here.

What do you think?

Global Trends Relevant to Taxation

I am a fan of identifying and analyzing trends, particularly as they may indicate areas where tax rules and systems may need to be updated/modernized. Today, I came across a January 2012 article by Chris Walsh of Vertex, on six global trends relevant to the tax world. The trends:

1. Global economic environment
2. Globalisation
3. Tax talent
4. Environmental issues
5. Legislative environment and "hyper regulation"
6. Technology

I encourage you to read the short article for all of the details.  For tax talent, Walsh notes that we may have a shortage soon given impending retirements. He also notes the need for tax talent with international tax understanding. This trend is good news for the growing number of full-time students in the SJSU MST Program.

The environmental trend is already here in the US with calls to reduce tax preferences for oil, gas and coal. President Obama also wants to bring back the Superfund taxes. Also, some type of carbon omissions tax could help us reduce our greenhouse gas emissions and raise money to pay down the deficit.

Two more trends I would add:

• Entrepreneurship. I think we will be seeing more young people start their own businesses, particularly ones that focus on the Internet or personal services. 
• Addressing growing inequalities.  The "occupy" groups are drawing attention to the growing income and wealth gaps between the 99% and the top 1%, as are reports from various think tanks and the OECD.

What do you think? Do you agree with the trends noted above? Any to add?

Growing income inequality and the federal tax system

Laura Tyson of the Haas School of Business at UC Berkeley has a post on the Economix blog of the NY Times for 11/18/11 - "Tackling Income Inequality." She summarizes and analyzes data on changes in income and its elements (such as wages and capital gains) and how the income of the top 1% has "soared." She notes that there is reason for the Occupy Wall Street folks to focus on this topic.

The data is from a recent Congressional Budget Office report - Trends in the Distribution of Household Income Between 1979 and 2007 (10/11).

Tyson focuses on taxation of capital gains. She notes that when she was President Clinton's economic adviser, she led a study on the effects of reducing the capital gains rate. Per Tyson: "We concluded that a cut would decrease future tax revenue, would contribute to rising inequality and would not increase saving and investment as its advocates asserted." She also reminds readers that to reach a compromise on the budget, President Clinton signed legislation that dropped the top capital gains rate from 28% to 20% in 1997. That rate was dropped to 15% and also for qualified dividends, a few years later by President Bush and today, many believe it should stay at that rate.

Tyson also notes what is an income inequality issue and what becomes a federal revenue issue: "Capital and business income are much more unevenly distributed than labor income and have become more so over time. Capital gains income is the most unevenly distributed — and volatile — source of household income."

I have blogged on this before to offer another perspective to consider with respect to the concern some raise that many individuals with income under $50,000 don't pay federal income tax (for example, 5/8/11 post). (For more on data from Tax Policy Center that for 2011 46% won't owe federal income tax - see their blog post of 7/27/11.) A 15% capital gains rate versus a 20% capital gains rate provides a $3,000 tax savings to someone with $60,000 of capital gains. So why a focus on someone with $50,000 of income perhaps not owing $3,000 of tax rather than the higher income person (with capital gain income) saving - and it is an even greater savings if the capital gains rate had stayed at 28%.

Back to the Tyson article - she suggests to address budget problems and reduce growing income inequality, to return ordinary and capital gains tax rates to what they were when Clinton left office, taxing some carried interests as ordinary income, adding a progressive consumption tax (no details of what it might be), and lowering the corporate tax rate (paying for it with the increased capital gains rate).

I encourage reading of both Dr. Tyson's article and the CBO report - interesting data and ideas.

What do you think?