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JCT Staff Tax Simplification Study: Aggressive Proposals Will Shape Future Tax Policy DebateWednesday, May 10, 2001 Deloitte & Touche OnLine The staff of the Joint
Committee on Taxation (JCT) on
April 27 released a wide-ranging set of proposals aimed at simplifying the
federal tax system. Although many of the more
than 150 proposals focused on individual taxes, the study also includes
significant changes that would affect corporate and international
taxation, such as repealing the corporate alternative minimum tax (AMT); replacing the current rate
system for capital gains with a fixed percentage deduction; applying the
active business requirement of section 355 on an affiliated group basis;
and eliminating the rules applicable to foreign personal holding companies
and foreign investment companies. It is clear that the aggressive recommendations included in this study cannot
be implemented in the short term; however, the boldness of the JCT staff's
proposals make this an important document that politicians and interest
groups will use as leverage in tax policy debates in the coming years. Significant Problem Anyone who ever doubted the complexity of the current tax system need only consider a few statistics cited in the study:
The price of this complexity, the study suggests, is reduced taxpayer compliance through inadvertent errors or intentional behavior. Lower compliance, in turn, creates disparate treatment of similarly situated taxpayers, which leads to taxpayer disillusionment and possible manipulation of the tax laws. Government's inability to explain complex tax law to taxpayers in a concise and understandable manner through forms, publications, and other guidance also leads to confusion and reduced compliance, the JCT staff said. Ultimately, all of these factors result in administrative headaches for the Internal Revenue Service and increased compliance costs for taxpayers, the study concludes. In formulating its recommendations, the JCT staff examined three general categories of complexity:
AMT, Capital Gains, Phase-Outs One of the most far-reaching
recommendations in the JCT study is the proposed repeal of both the
individual and corporate AMT. The
current rules for individual AMT require burdensome and complex
computations. The AMT system,
which is not indexed for inflation, treats large families unfairly and has
led to disparate tax treatment depending on a taxpayer's state of
residence, the study notes. And
the problems will only grow over time: JCT estimates that during the
period 2002-2011, the number of individual AMT taxpayers will jump from
1.9 million to over 16 million or 11.2 percent of individual tax
returns filed in 2011. On the corporate level, the study concludes that "corporate AMT adjustments do not necessarily produce a more accurate measurement of economic income, as was the original purpose of the corporate AMT." The study does not take into account the clear need for a transition period to prevent unfair treatment for taxpayers with existing AMT credits. On the corporate level, the study concludes that "corporate AMT adjustments do not necessarily produce a more accurate measurement of economic income, as was the original purpose of the corporate AMT." Smaller AMT "Fixes" These recommendations bolster the case for those who believe that the AMT system should be reformed in smaller ways to fix certain problems without the high cost of full repeal. Allowing personal exemptions for individuals against the AMT, ensuring that income averaging for farmers does not increase a farmer's liability for the AMT, allowing state and local taxes to be deducted in computing the AMT, repealing the limitation on the use of foreign tax credits under the AMT, and repealing the AMT treatment of incentive stock options are just a few of the smaller AMT "fixes" introduced by Congress this year. Individual Capital Gains and Losses The JCT staff recommends replacing the current capital gains rate system with a deduction equal to a fixed percentage of the net capital gain. According to the study, this proposal would provide simplification to the 27 million returns that have capital gains or losses in 2001. To the extent that a proposal like this generates debate, it opens up the question of what the fixed percentage should be. Eliminating Hidden Tax Increases
Corporate Recommendations Collapsible Corporation Provisions Noting that they are "[among] the most complex in the Internal Revenue Code," the JCT staff calls for repeal of the collapsible corporation provisions. Section 355 "Substantially All" Test The study recommends eliminating the "substantially all" test under section 355, thus applying the active business requirement on an affiliated group basis. According to JCT staff, this treatment is consistent with the treatment accorded to affiliated groups for other purposes under section 355. This recommendation would simplify business planning for corporate groups that use a holding company structure. Corporate Reorgs Rules relating to the treatment of "boot" received by a shareholder in a corporate reorganization involving corporations under common control or a restructuring of a single corporation should be conformed to the rules relating to the redemption of stock, the study suggests. The JCT staff also recommends permitting assets acquired in a certain tax-free reorganizations to be transferred to a controlled subsidiary without affecting the tax-free status of the reorganization. Uniform Definition of "Family" The study calls for using a uniform definition of "family" (brother, sister, spouse, ancestors, and lineal descendants) when applying the attribution rules used to determine stock ownership. It should be noted however, that the JCT staff's definition does not address what many practitioners believe is the most significant shortcoming of the attribution rules: the inability to prevent attribution in situations where the facts clearly show the "related" parties have hostile interests. The JCT staff's definition of "family" does not address what many practitioners believe is the most significant shortcoming of the attribution rules: the inability to prevent attribution in situations where the facts clearly show the "related" parties have hostile interests. If this proposal goes forward, it is important to note that any change in the attribution rules should be done carefully, given their pervasive use throughout the code. For instance, the controlled foreign corporation (CFC) rules currently refer to the section 318(a) attribution rules when determining CFC status. If the JCT's proposal were implemented, it is possible that some foreign corporations that are not currently CFCs might be classified as CFCs as a result of the more expansive definition of "family." Other Corporate Provisions Other corporate
recommendations include treating stock redemption incident to a divorce as
a taxable redemption of the stock of the transferor spouse, and limiting
the application of the complex and burdensome section 304 rules only to
situations in which it results in a dividend (other than a
dividends-received deduction). |
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Pass-Through Entities Partnerships The study recommends modernizing references in the code to "general partners" and "limited partners" to make them consistent with the purpose of the reference; eliminating the special reporting and audit rules for electing large partnerships; and conforming the timing rules for guaranteed payments to partners and for transactions between partners and partnerships. The timing rule proposal could be significant to cash basis partners that lend money to, or enter into other transactions with, accrual basis partnerships. Under the proposal, these partners may be required to report income before receiving cash. S Corporations The special rules for taxation of electing small business trusts should be eliminated, with the regular subchapter J rates applying to the trusts and their beneficiaries, the study suggests. International Tax Recommendations Elimination of Old Anti-Deferral Regimes The study proposes to eliminate the rules applicable to foreign personal holding companies (FPHCs) and foreign investment companies. This simplification primarily would benefit U.S. individuals that are direct or indirect shareholders in closely held foreign corporations. The repeal of the FPHC regime, in particular, would greatly simplify tax planning for these corporations and would eliminate significant "traps for the unwary." The repeal of the FPHC regime would greatly simplify tax planning for these corporations and would eliminate significant "traps for the unwary." Look-Through Rules for 10/50 Companies The JCT staff calls for applying the look-through approach to all dividends paid by a 10/50 company for foreign tax credit purposes. For the most part, this change would be very beneficial for U.S. corporations that are shareholders in 10/50 companies. Conform Sections 30A and 936 The study proposes conforming the application of the section 30A Puerto Rico Economic Activity Credit and the section 936 Puerto Rico and Possession Tax Credit across all possessions and combining the rules into one code section. The JCT staff made this recommendation conditional on congressional extension of the credits beyond 2005. The study does not indicate whether the JCT anticipates that Congress will extend the credits and, if so, whether or not Congress would grant the extension only to current credit claimants or to new credit claimants as well. Other Recommendations Other international tax provisions include capitalizing costs incurred in producing property or acquiring property for resale; eliminating the secondary withholding tax with respect to dividends paid by certain foreign corporations; allowing domestic corporations to claim deemed-paid foreign tax credits with respect to a foreign corporation that is held indirectly through a foreign or U.S. partnership; raising the subpart F de minimis threshold to the lesser of 5 percent of gross income or $5 million (from the current law $1 million threshold); and eliminating the 30 percent tax on certain U.S.-source capital gains of nonresidents. Depreciation and Accounting Methods Depreciation Noting that modifying current-law class lives would be an overwhelming project requiring an asset-by-asset study in order to determine class lives of new and existing assets, the study makes no specific recommendations regarding the overall depreciation regime, recovery periods, or methods for particular classes of assets. Accounting Method Recommendations The study calls for permitting taxpayers with less than $5 million of average annual gross receipts to use the cash method; permitting taxpayers to amortize organizational expenses over a 60-month period through combining sections 248 (relating to organizational expenditures) and 709 (relating to the treatment of organization and syndication fees) into one tax code provision governing the treatment of organizational costs of all types of entities; and eliminating the mid-quarter convention for depreciable property. IRAs, Retirement Plans, and Employee Benefits The study makes several recommendations that affect retirement plans and employee benefits. IRA Eligibility Limits The JCT staff recommends eliminating the eligibility income limits for contributing to a traditional or Roth IRA and for converting traditional IRAs to Roth IRAs. The study also calls for eliminating nondeductible contributions to traditional IRAs. This recommendation would promote simplification because nondeductible IRAs require burdensome recordkeeping of the nondeductible contributions made until distribution. Since distribution can be many years into the future, record retention can be a lengthy and complex process. Uniform Definitions The study calls for using uniform definitions of (1) "compensation," (2) "highly compensated employee," and (3) "owner" for all qualified retirement plan and employee benefit purposes. This proposal may not be as simple as it sounds, however. Generally, private sector plans can already define "compensation" in one way for all purposes, but it is often advantageous not to do so. For example, many plans tie base benefits to base pay, disregarding bonuses and overtime, while others permit elective deferrals from regular pay and bonuses, but not from extraordinary compensation items (e.g., taxable fringe benefits). The study calls for using uniform definitions of (1) "compensation," (2) "highly compensated employee," and (3) "owner" for all qualified retirement plan and employee benefit purposes. This proposal may not be as simple as it sounds, however. Other recommendations include
Worker Classification The JCT staff notes
that complexities in current law relating to a worker's classification as
an employee or independent contractor have created confusion among
taxpayers; administrative disputes and litigation over classification;
inconsistent enforcement and application of the rules by the IRS;
disparate treatment of similarly situated taxpayers; and loss of federal
revenue due to misclassification. Given the significant policy issues involved in worker
classification, the study does not make a specific recommendation for
simplifying the rules. It
does, however, state that simplification is warranted in the event that
the policy issues are resolved.
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Financial Products and Insurance Straddle Rules The study contains a number of proposals for simplifying and clarifying the straddle rules of section 1092. Of greatest significance to taxpayers is a proposal to adopt an identification and capitalization regime for straddle losses in place of the existing loss deferral rule. The other major proposal is to repeal the present exception to the straddle rules for actively traded stock (the "stock exception"). In addition, the JCT staff recommends the repeal of section 1233 (which would become largely superfluous after elimination of the stock exception), elimination of the qualified covered call exception of section 1092(c)(4), and a mark-to-market requirement in cases where a taxpayer closes out a straddle position by delivery of property. All of these recommendations are likely to benefit taxpayers by facilitating the use of hedging techniques in legitimate trading and investment activities. Recommendations for simplifying the straddle rules are likely to benefit taxpayers by facilitating the use of hedging techniques in legitimate trading and investment activities. Interest Computation The eight different regimes for imposing interest on deferred taxes should be consolidated into three separate regimes of (1) an annual interest charge, (2) a look-back rule in which estimates are used, and (3) a look-back rule in which the tax is allocated to prior years based on the applicable federal tax rate, according to the study. Annuities The study calls for redrafting section 72 to eliminate "overly convoluted" language, as well as separating the section 72 provisions applicable to qualified retirement plans and combining them with other rules applicable to taxation of distributions of such plans. Insurance The JCT staff recommends
eliminating the special rules permitting a deduction for certain reserves,
along with the special rules provided to Blue Cross and Blue Shield
organizations enacted in 1986. The
staff also calls for eliminating the two five-year rules relating to
consolidated returns of affiliated groups that include life insurance
companies and nonlife insurance companies. Tax Credits Combine the Work Opportunity Tax Credit and Welfare-to-Work Tax Credit Citing the complexity involved for employers who hire workers in both targeted groups, the JCT staff recommends combining the two credits and harmonizing the rules. This would eliminate burdensome calculations and the often duplicative compliance responsibilities, the study notes. According to the JCT staff, each employer should be able to look at a uniform set of rules regarding the employment of workers in any of the targeted groups. Low-Income Housing Tax Credit The study calls for conforming the payout period for the credit to the initial compliance period (15 years), eliminating the current-law credit recapture rules. Educational Assistance The study also recommends the permanent extension of the employer-provided exclusion for educational assistance, noting that it would provide certainty for employers, employees, and the IRS, and would eliminate withholding and other issues that arise solely because of the temporary nature of the exclusion. The study does not address whether the exclusion should apply to graduate studies. Like-Kind Exchanges The JCT staff determined that in section 1031 like-kind exchanges, taxpayers incur excessive costs complying with the present-law tax rules, with no resulting non-tax benefit. The recommendation would permit taxpayers to elect to "roll over" gain from the disposition of appreciated business or investment property if the like-kind property is acquired within 180 days before or after the date of disposition. The study also recommends that for purposes of determining whether property satisfies the holding period requirement under section 1031, a taxpayer's holding period and use of property should apply in the case of property (1) contributed to a corporation or partnership in a transaction described in sections 351 or 721; (2) acquired by a corporation in connection with a transaction qualifying as a reorganization under section 368; (3) distributed to a partnership by a partner; or (4) distributed by a corporation in a section 322 transaction. This recommendation would remove the confusion and uncertainty under section 1031 with respect to whether a taxpayer is considered to hold property for productive use in a trade or business or for investment when the property has been recently transferred to the taxpayer. Excise Taxes Alcohol and Tobacco The study recommends that the three separate excise taxes currently imposed on alcoholic beverages be consolidated into a single tax, with the rate based on alcohol content of the beverage. For tobacco, the JCT staff calls for consolidating the current excise taxes on pipe tobacco, roll-your-own tobacco, and cigarette papers and tubes into a single tax on pipe and roll-your-own tobacco. Communications The JCT staff recommends repeal of the 3 percent federal communications excise tax. Calling the excise tax "obsolete," the study states that the "speed at which computer technology is changing makes it difficult to write tax provisions today that will accurately reflect the state of the industry even within a relatively few years." Calling the communications excise tax "obsolete," the study states that the "speed at which computer technology is changing makes it difficult to write tax provisions today that will accurately reflect the state of the industry even within a relatively few years." Congress approved a repeal of the tax which was enacted to fund the Spanish-American War last year and it remains a popular proposal among members. Revenue considerations and other tax priorities ultimately will dictate whether the excise tax is repealed. Other Recommendations Reduced Emissions Vehicles The JCT staff calls for changing the tax benefit for reduced emissions to a deduction of qualified expenses related to all qualifying vehicles. Highway Trust Fund The study calls for eliminating or consolidating the non-fuels taxes that are imposed to finance the Highway Trust Fund. Investment Income of Private Foundations The JCT staff recommends eliminating the excise tax on investment income of private foundations. Where are We Headed? Congressional lawmakers will likely use this report as a source of proposals that move in the direction of simplification. While wholesale adoption of the recommendations is difficult to imagine, their piecemeal adoption over several years is possible. As a reality check, it's important to remember that the JCT staff did not take any potential revenue loss or gain into account when making these recommendations. The cost of AMT repeal alone, for example, could be enormous. Last fall, the JCT pegged the estimated cost of fixing the AMT problems that would be created by President Bush's proposed tax cuts at $200 billion over 10 years. Complete repeal of both the individual and the corporate AMT would be significantly higher. In the short term, however,
the study will provide ammunition for politicians and interest groups that
favor particular changes outlined by the JCT staff.
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