The House, on April 15, voted 238 to 179 approving the Taxpayer Assistance and Simplification Bill of 2008 (HR 5719). One provision would prohibit the use of third-party debt collectors engaged by the IRS to collect unpaid tax liability. Another provision would provide that distributions from health savings accounts (HSA) for qualified medical expenses would be excluded from gross income only to the extent such expenses were substantiated. Democrats believe some taxpayers are using the provision to purchase luxury goods and services. President Bush has threatened to veto the legislation. In yet another indication of how the estate tax pendulum has swung back, Congress may take legislative action against perpetual “dynasty” trusts.
Congressional concern about income-shifting will probably result in the gift tax exemption remaining at its current level of $1 million. While gifts in excess of $1 million do result in an effective “freeze,” and could conceivably reduce future estate tax liability, prepayment of gift tax at the current rate of 46% for taxable gifts in excess of $1 million seems ill advised considering that the estate tax rate may soon be less than 20% and the exemption amount may well climb to $4 or $5 million. On the other hand, leveraging the $1 million gift tax exclusion by prudent use of installment sales to grantor trusts, family entities, GRATS and QPRTs, seems worthwhile.
President Bush favors increasing contribution limits to Health Savings Accounts (HSAs) which grow tax-free, and permitting tax-free withdrawals to pay health insurance premiums. The Administration also advocates increasing the contribution limit to the annual spending limit from the plans, currently $5,250 for an individual and $10,500 for a family. Mr. Bush believes that permitting health premiums to be paid tax-free from HSAs would alleviate the imbalance between people who receive health insurance through their jobs — and pay no tax on their premiums, and people who buy their own health insurance — who must use after-tax dollars.
The Joint Committee on Taxation made the following proposals:
¶ To amend the kiddie tax rules to require that the unearned income of a minor child (above a $2,500 exemption) be taxed at the highest marginal rate applicable to that type of income, rather than at the parents’ marginal rate. Parents would also no longer be permitted to elect to include the child’s income on their own tax return, necessitating a separate tax return for the child.
¶ To curtail the use of dynasty trusts by prohibiting the allocation of GST exemption to a “perpetual dynasty trust” that is subject either to no rule against perpetuities or to a relaxed rule against perpetuities. Many states have now either eliminated the rule against perpetuities or relaxed the rule.
¶ To limit valuation discounts for FLPs by valuing a transferred partial interest at a pro rata portion of the value of the total interest. The new rules would increase revenues by $3.6 billion between 2005 and 2014. Even without such new legislation, Section 2036 poses a substantial threat to claiming valuation discounts associated with family entities.
Falling tax rates under EGTRRA resulted in a 6.1% decrease in income tax revenues in 2003, but the fraction of taxes paid under the AMT increased significantly. The AMT is expected to affect 21.6 million taxpayers in 2006 unless Congress limits its reach. However, eliminating the AMT would cost the Treasury an estimated $12.22 billion in 2006.
The President’s Advisory Panel on Tax Reform made several proposals in its report issued November 1, 2005:
¶ To repeal the AMT and adopt a regime which (somewhat ironically) repeals or limits deductions that would be disallowed tax preferences under the current AMT, while lowering and simplifying tax rates;
¶ To eliminate the deduction for state and local taxes;
¶ To repeal the deduction for home mortgage interest and replace it with a smaller tax credit;
¶ To impose annual income tax on the inside build-up in life insurance policies, unless the policy cannot be cashed out; and
¶ To impose annual income tax on deferred compensation and annuities. However, annuities and deferred compensation plans currently in existence would be exempt from the new rules.
Under the Bankruptcy Abuse Prevention Act of 2005, IRAs and Roth IRAs are exempt from the bankruptcy estate to the extent the debtor’s interest does not exceed $1 million, adjusted for inflation. The Act also provides that no discharge will be provided for tax debts for which a fraudulent return was made or tax evasion was attempted.
The Energy Policy Act of 2005 provides incentives to purchase alternative power vehicles and residential solar heating equipment. Credits are also available for the construction of new energy-efficient homes. A new deduction will be allowed for expenditures made for energy-efficient commercial structures in the U.S. if part of a plan to reduce energy costs.
The Katrina Emergency Tax Relief Act of 2005 provides that individuals who lived in a Katrina disaster area may withdraw up to $100,000 from IRAs and qualified plans within one year after the area was declared a disaster, without paying the 10% penalty tax for premature distributions. Further, such withdrawals are exempt from income tax if recontributed to an IRA or qualified plan within three years.