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Tax Week in Review

Monday, May 14, 2001

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Senate Finance Committee Announces Tax Cut Deal

The Senate Finance Committee on May 11 released a compromise tax cut plan reached by committee Chairman Charles Grassley, R-Iowa, and ranking Democrat Max Baucus of Montana.

According to congressional sources and news reports, the compromise package would scale back or further delay several of President Bush’s tax cut proposals in order to fit under the $1.35 trillion, 11-year ceiling dictated by the House and Senate budget plans passed earlier in the week. It also includes proposals not addressed by the White House.

Marginal Rates -- Notably, the compromise agreement would reduce the top individual income tax rate from 39.6 percent to 36 percent -- not 33 percent as advocated by the White House. The agreement also would create a new 10 percent rate bracket retroactive to January 1, 2001, and drop the 28-, 31-, and 36 percent brackets by 3 percentage points each between 2002 and 2007.
Limitations on Itemized Deductions -- The proposal would increase the starting point of the overall limitation on itemized deductions for all taxpayers (other than married couples filing separate returns) to the starting point of the personal exemption phaseout for married couples filing a joint return, effective beginning in 2009. If this provision had been effective for 2001, the change would have saved some high income taxpayers subject to the limitation approximately $2,000.
Limitations on Personal Exemptions -- The proposal would repeal the current-law phaseout of deductions for personal exemptions, beginning in 2009.
Marriage Penalty, Child Credit -- The agreement would double the child tax credit to $1,000 and provide marriage penalty relief by raising the standard deduction for married couples to twice the rate for single taxpayers between 2006 and 2010.
Estate and Gift Taxes -- The agreement would hike the existing $675,000 estate tax exemption to $4 million over 10 years and repeal the tax outright by 2011. It would lower the top rate from 55 percent to 50 percent by 2002. Unlike the Bush and House GOP proposals, however, the Finance Committee agreement would retain the gift tax.
Pensions and Retirement Accounts -- In a major departure from the president’s tax cut agenda, the Finance Committee agreement would raise contribution limits for IRAs to $5,000 (from $2,000) and hike contribution limits for employer-sponsored retirement plans -- such as 401(k)s
-- to $15,000 (from $10,000). It also would increase portability of pension benefits for workers who change jobs and permit “catch-up” retirement account contributions for workers age 50 and older.
S Corporation ESOPs -- The sole intentional revenue raiser in the agreement would prohibit allocations of stock in an S corporation ESOP to certain classes of owners of the corporation.
Alternative Minimum Tax -- The agreement would allow the child credit to be claimed against the alternative minimum tax (AMT) permanently and would repeal the AMT offsets of refundable credits. The proposal increases the AMT exemption amount by $4,000 for married couples filing a joint return and by $2,000 for individuals for years 2001 through 2006. (The provision sunsets on December 31, 2006.)
Employer-Provided Educational Assistance -- The proposal would extend the current-law exclusion for employer-provided educational assistance to graduate education and make the exclusion (as applied to both undergraduate and graduate education) permanent.
Education Savings -- The agreement would eliminate the caps on student loan interest deductions and raise the amount that can be contributed to an education savings account to $2,000 (from $500).

(For a side-by-side comparison of these provisions with the tax relief proposals passed by the House of Representatives, see the chart below.)

Bipartisan Victory or Blow to Democrats? -- In a news release, Grassley emphasized that the package he crafted with Baucus was a bipartisan compromise. “You don’t put together the biggest tax cut in two decades without considering all the points of view. . . . We knew we wouldn’t get the people’s business done without a bipartisan agreement. That’s the reality of a 50-50 Senate. . . . It wasn’t easy to arrive at a final agreement. I can vouch for the fact that among the 10 Republicans, there are many different points of view. In the end, no one got everything he or she wanted, including me,” Grassley said.

But Baucus’ decision to align himself with Grassley and the Republicans is a blow to the Democratic leadership, who had wanted him to hold off for a time to push for their priorities. There is talk that Democrats will present their own tax bill for consideration at the Finance Committee markup slated for May 15.

Budget Blueprint -- The Finance Committee agreement comes just one day after the Senate voted 53-47 -- with five Democrats and two Republicans breaking ranks -- to pass a $1.97 trillion fiscal year 2002 budget resolution. The House had passed the same measure on May 9 by a near party-line vote of 221-207.

The budget blueprint, which sets spending parameters for the congressional appropriations process, would authorize a tax cutting reconciliation bill totaling $1.35 trillion over the next 11 years. Of that, $100 billion would be used for an economic stimulus tax cut in FY 2001 and FY 2002. The remaining $1.25 trillion would be used for a 10-year tax cut beginning in FY 2002.

Tax Cut Scorecard
Provision	House Proposal	Senate Finance Committee Proposal
Rate Reductions	1. Creates new 10% bracket for first $6,000 of taxable income for singles, first $10,000 for heads of households, and first $12,000 for married couples, with indexing beginning in 2007; rate set at 12% in 2001 and 2002, 11% in 2003 through 2005, and 10% in 2006. 2. Phased-in reduction of the various income tax rates until fully reduced by 2006 as follows: 39.6% and 36% rates reduced to 33%; 31% and 28% rates reduced to 25%.	1. Same as House, except 10% bracket is effective in 2001. Rest of the 15% bracket will remain in place. 2. Similar to House, except the rates are fully reduced by 2007 as follows: 39.6% rate is reduced to 36%; 36% rate is reduced to 33%; 31% rate is reduced to 28%; and 28% rate is reduced to 25%. 3. Increases starting point for the phaseout of itemized deductions for high income taxpayers, starting in 2009. Repeals phaseout of personal exemptions.
Marriage Penalty and Child Credit	1. Standard deduction for joint filers set at twice that of singles beginning in 2002; 15% rate bracket set at twice single beginning in 2004. 2. Doubles the child credit to $1,000 by 2006. Includes provisions that ensure AMT won’t take away all the child credit’s benefit.	1. Similar to House except doubling of standard deduction and of 15% rate bracket would phase in over five years beginning in 2006. 2. Doubles child credit by 2011. Includes House AMT provisions. Credit partially refundable for those without tax liability.
Estate Tax	Phases in repeal of estate, gift, and generation- skipping transfer taxes beginning in 2002 (rates going from 55% to 53% in 2002) with full repeal by 2011; carryover basis applies to transfers at death after 12/31/10 of assets fully owned by decedents, except: (1) $1.3 million of step-up for any transfer and (2) an additional $3 million of basis allowed for assets going to surviving spouse.	1. Similar to House bill, except rate reduction from 55% to 50% by 2002, with rates to be lowered over time. Exemption increases to $1 million in 2002, and $4 million by 2010. 2. Retains gift tax, but lowers rates.
IRA/401(k) Provisions	1. Phases in increase in IRA contribution limits to $5,000 by 2004, and 401(k) limits to $15,000 by 2006; indexed thereafter. 2. IRA Catch-Up Contributions -- Increase maximum contribution limits for traditional and Roth IRAs for individuals age 50 and above by an additional $5,000 for 2002 and 2003.	1. Similar to House, except phases in increased IRA and 401(k) contribution limits by 2011; indexed thereafter. 2. IRA catch-up provision increases maximum contribution limit by an additional $2,000 by 2011. 3. Tax credit for low- and middle-income savers of up to 50 percent of a $2,000 contribution.
Education	Not addressed.	1. Expands Educational IRA contribution limits to $2,000. Allows money to be distributed on a tax-free basis from pre-paid college tuition plans. 2. Eliminates 60-month cap and increases phaseout ranges on deductibility of student loan interest. 3. Permanently extends the exclusion of employer-provided educational assistance for undergraduate and graduate courses.
AMT Relief	Not addressed.	Increases AMT exemption amount by $2,000 (single) and $4,000 (joint) in 2001 through 2006; sunset 12/31/06.

Reconciliation Instructions: The Taxwriters’
Marching Orders

The budget resolution gives slightly different reconciliation instructions to each of the two congressional taxwriting committees. The Ways and Means Committee must adopt a $1.35 trillion tax cut between fiscal years 2001 and 2011. The Finance Committee is also charged with approving a $1.35 trillion tax cut over the same period, but $100 billion in reductions must come in fiscal years 2001 and 2002. The House, consequently, has more flexibility in designing its proposal.

Both committees must report reconciliation bills by May 18. Any differences between the two reconciliation bills will be resolved in conference.

Reconciliation bills are provided procedural safeguards in the Senate. They are not subject to a filibuster, which can typically be stopped only by the votes of 60 senators, and the period for debate is limited. In the House, the powerful Rules Committee sets the terms of debate.

More Tax Cuts Possible -- In addition to a $1.35 trillion tax cut, the budget resolution allows for three other tax cuts to be considered outside of reconciliation. These would extend tax provisions expiring in 2001 for one year, reduce Securities and Exchange Commission (SEC) fees, and permit the Federal Reserve to pay interest on deposits. These revenue reductions would bring the total amount of tax relief explicitly authorized by the resolution to $1.369 trillion between fiscal years 2001 and 2011.

Congress could go beyond the $1.369 trillion currently authorized for tax reductions. The budget resolution includes a provision that allows any projected increase in surplus estimates to be used for tax reductions. The Congressional Budget Office is expected to release updated budget projections in July. The July projections, however, could be lower than currently expected due to a softening economy.

The resolution also sets aside up to $28 billion between fiscal years 2002 and 2004 that could be used to provide tax incentives for uninsured individuals to purchase health insurance. Bills considered under these provisions would not benefit from reconciliation protection. Furthermore, with the concurrence of 60 senators to waive budget act points of order and prevent filibusters, lawmakers could also pass any other tax cut they may choose with the $897 billion in non-Social Security surpluses that Congress now expects to remain following implementation of the resolution’s provisions. In the House, the Rules Committee could set advantageous terms of debate and waive budget act points of order.

The House has already begun action on tax bills outside of reductions specifically authorized by the budget resolution. House Ways and Means Committee members on May 9 passed three tax cut measures -- at a cost of $3.2 billion total over 10 years -- that would raise the adoption tax credit, allow more foster families to use existing foster-care tax benefits, and enhance survivor benefits for public safety officers killed in the line of duty.

“Only a Blueprint” -- Ways and Means Committee Chairman Bill Thomas, R-Calif., said the committee would continue to pass tax bills for consideration on the floor, even though Congress just adopted a budget resolution. Committee members need to submit “product,” to effectively compete for any more money that is made available, Thomas said.

Committee member Jim Nussle, R-Iowa, who is also chairman of the House Budget Committee, concurred, saying, “the budget is only a blueprint,” whose actual execution is not yet nailed down.

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The measure mirrors the budget outline that President Bush sent to Congress in February, although with a smaller tax cut than his original target of $1.6 trillion and slight shifts in spending priorities. Still, Bush praised the action, calling it a “victory for fairness and the American people.”

“The economy continues to show troubling signs and we must take decisive steps, like this vote today, to ensure sound fiscal policy,” the president said.

Budget Critics -- Democrats voiced strong reservations about the budget resolution, claiming that it emphasized tax cuts over critical spending priorities such as education, defense, and health care. Senate Minority Leader Tom Daschle, D-S.D., said the resolution was “anchored by a tax cut that is irresponsible in its size and unfair in its structure.”

“There is no way they can fund their core priorities without raiding Social Security and Medicare if a $1.35 trillion tax cut goes through.” Daschle said. “I’m saddened by our actions over the last few days because we could so easily shift back into deficit.”

House Minority Leader Dick Gephardt, D-Mo., agreed. “The majority is putting out a budget that I believe sacrifices our achievements on the altar of a massive tax cut for the wealthiest individuals [and] takes away from our ability to deal with the needs of all the people in our country.”

What’s Next? -- Now that the House and Senate have approved their respective versions of the budget resolution, the differences will be worked out in a conference committee and the agreement will be sent back to each body for final approval. Once approved, the final agreement does not need to be sent to the president for his signature, but it will be used as a blueprint for congressional appropriations subcommittees in setting annual spending allocations for the coming fiscal year. (For additional details, see related story.)

At the same time, the Senate Finance and House Ways and Means Committees will draft tax relief bills that conform to the budget resolution. Because the equally split Senate can hold up legislation, the Finance Committee version will impose tight parameters on the final bill.

Grassley has said he hopes for a Finance Committee markup on May 15 so that floor consideration can occur later that week. The Senate will consider the tax bill under special rules that limit debate and amendments.

Republicans have said they hope to have a final tax relief bill signed into law by Memorial Day.

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Bush Administration Rejects OECD Initiative

Treasury Secretary Paul O’Neill announced May 10 that the United States will not support an Organization for Economic Cooperation and Development (OECD) initiative on tax havens. The OECD, as part of its efforts to stamp out harmful tax competition, undertook an initiative to blacklist those countries that are considered to be tax havens based on several factors including their low tax rates.

The Clinton administration had supported the initiative and included a measure in its budget for FY2001 to limit the benefits from transactions involving identified tax havens. However, many U.S. lawmakers on both sides of the aisle opposed the initiative and called on the Bush administration to withdraw U.S. support for the project.

In a written statement, O’Neill said the initiative is “too broad” and not in line with Bush administration tax and economic priorities. The work of the OECD must be “refocused,” on information sharing and preventing illegal evasion, he added.

European Union Internal Market Commissioner Frit Bolkestein told a May 11 news conference in Washington that the OECD initiative will continue despite the withdrawal of U.S. support.

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Washington Date Book -- Week of May 13

Monday, May 14

E-COMMERCE TAXATION -- The New York University School of Continuing and Professional Studies will hold a two-day conference in Washington concerning e-commerce taxation. For more information, call (212) 998-7171.

Tuesday, May 15

ANTI-MORRIS TRUST REGULATIONS -- The Internal Revenue Service will hold a hearing concerning proposed regulations on the scope of a section 355(e) plan. The hearing will take place at 10:00 a.m. in Room 4718 of the IRS Building, Washington, DC.

Wednesday, May 16

HEDGING TRANSACTIONS -- The Internal Revenue Service will hold a hearing concerning proposed regulations on the character of hedging transactions. The hearing will take place at 10:00 a.m. in the IRS Auditorium, IRS Building, Washington, DC.

The information contained in Tax News & Views is for general purposes only and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Deloitte & Touche to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs. Therefore, the information should not be used as a substitute for consultation with professional accounting, tax, or other competent advisors. Please contact your local Deloitte & Touche professional before taking any action based upon this information.

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Tax News & Views is produced by the Legislative & Regulatory Services Group at Deloitte & Touche LLP.

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