[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]
IMPACT OF COMPLEXITY IN THE TAX CODE ON INDIVIDUAL TAXPAYERS AND SMALL
BUSINESSES
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
__________
JUNE 23, 1998
__________
Serial 105-46
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
52-037 cc WASHINGTON : 1998
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut BARBARA B. KENNELLY, Connecticut
JIM BUNNING, Kentucky WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
NANCY L. JOHNSON, Connecticut, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
PHILIP S. ENGLISH, Pennsylvania JOHN S. TANNER, Tennessee
WES WATKINS, Oklahoma KAREN L. THURMAN, Florida
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
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unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
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C O N T E N T S
__________
Page
Advisory of June 16, 1998, announcing the hearing................ 2
WITNESSES
A.J. Bafundo and Co., LLC:
Steve Bafundo................................................ 6
Anthony J. Bafundo........................................... 8
American Institute of Certified Public Accountants, Michael Mares 31
Citizens for Tax Justice, Robert S. McIntyre..................... 26
Connecticut Society of Certified Public Accountants, John L.
Evanich, Jr.................................................... 13
H&R Block, Robert A. Weinberger.................................. 38
Olandt, Carl R., New Britain, CT................................. 10
SUBMISSIONS FOR THE RECORD
Kennelly, Hon. Barbara B., a Representative in Congress from the
State of Connecticut, statement................................ 46
National Federation of Independent Business, statement........... 48
Neal, Hon. Richard E., a Representative in Congress from the
State of Massachusetts, statement.............................. 50
Ramstad, Hon. Jim, a Representative in Congress from the State of
Minnesota, statement........................................... 51
White House Conference on Small Business, Debbi Jo Horton,
Providence, RI; Joy Turner, Piscataway, NJ; Jill Gansler,
Baltimore, MD; Jack Oppenheimer, Orlando, FL; Paul Hense, Grand
Rapids, MI; Joanne Doherty, Houston, TX; Edith Quick, St.
Louis, MO; Jim Turner, Salt Lake City, UT; Sandra Abalos,
Phoenix, AZ; Eric Blackledge, Corvallis, OR, joint statement... 52
IMPACT OF COMPLEXITY IN THE TAX CODE ON INDIVIDUAL TAXPAYERS AND SMALL
BUSINESSES
----------
TUESDAY, JUNE 23, 1998
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 3:00 p.m., in
room 1100, Longworth House Office Building, Hon. Nancy L.
Johnson (Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON OVERSIGHT
CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
June 16, 1998
No. OV-19
Johnson Announces Hearing on the Impact
of Complexity in the Tax Code on Individual
Taxpayers and Small Businesses
Congresswoman Nancy L. Johnson (R-CT), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing on the impact of complexity in the tax
code for individual taxpayers and small businesses. The hearing will
take place on Tuesday, June 23, 1998, in the main Committee hearing
room, 1100 Longworth House Office Building, beginning at 2:30 p.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only.
Witnesses will include representatives from organizations representing
individual taxpayers and small businesses. However, any individual or
organization not scheduled for an oral appearance may submit a written
statement for consideration by the Committee and for inclusion in the
printed record of the hearing.
BACKGROUND:
When the Federal tax system was established in 1913, the
legislation was only 19 pages long. Today, the Internal Revenue Code
has ballooned to nearly 2,300 pages, not counting regulations. The
resulting compliance burden on taxpayers is enormous, especially on
middle-income taxpayers and on small businesses.
Many studies have been done documenting the impact of this
complexity on individuals and small businesses. For example, one study
showed that U.S. taxpayers spent more than five billion hours preparing
tax returns with compliance costs at more than $200 billion in 1998.
Two-thirds of compliance costs were bourne by businesses, and small
businesses face the brunt of these costs. Another study has shown that
some small businesses may pay more than $700 in compliance costs for
every $100 that they pay in taxes.
Because of the problems caused by the complexity of the current tax
code, there are many efforts in Congress to replace the tax code.
However, in the interim, simplification of the most complex provisions
of the code may help to significantly reduce the burden on individual
taxpayers and small businesses.
In announcing the hearing, Chairman Johnson stated: ``The
complexity of the tax code is staggering. Every year middle-income
taxpayers and small businesses spend more and more time, effort, and
money trying to prepare their tax returns. It is time that Congress
acts to reexamine the tax code and see if we can simplify or repeal
some of its most complex provisions. I believe that this hearing will
be a meaningful step toward simplifying the tax code to lessen the
burden on middle-income taxpayers and to allow entrepreneurs to
concentrate on their businesses and not their tax returns.''
FOCUS OF THE HEARING:
The Subcommittee will review current law to identify the impact of
complexity, in particular, on middle-income taxpayers and small
businesses, including: (1) the Alternative Minimum Tax (AMT) for
individuals, (2) small business expensing including computer software,
and (3) treatment of deductions in lieu of depreciation for small
businesses (section 179).
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Monday, July
6, 1998, to A.L. Singleton, Chief of Staff, Committee on Ways and
Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
public at the hearing, they may deliver 200 additional copies for this
purpose to the Subcommittee on Oversight office, room 1136 Longworth
House Office Building, at least one hour before the hearing begins.
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noted above.
Chairman Johnson of Connecticut [presiding]. The hearing
will come to order.
First, let me extend my apologies to those who are
witnesses this afternoon. It's very unusual for us to have to
delay a hearing, but three of the Members of this Subcommittee
were also conferees in the IRS reform bill. My Ranking Member,
Bill Coyne, who will be along any minute, and my second, Mr.
Portman. So there wasn't any way to avoid delaying the hearing
when the Senate offer didn't come over until so late in the
day. So I apologize to you all. But I appreciate your input,
and I'm particularly pleased to welcome here today some of my
friends from Connecticut--Mr. Bafundo and my friends, Carl and
Kathy Olandt, on whom I've relied for advice over many years.
So I'm very glad to have you here today.
When the Federal income tax system was established in 1913,
the legislation was only 15 pages long. Fifteen pages long,
isn't that incredible? Today, the Internal Revenue Code is
2,300 pages long, and this number does not include the hundreds
of thousands of pages of regulations, advisory opinions, and
court opinions. It is no wonder that the Taxpayer Advocate
reported to Congress last January that the number one concern
of individuals and small businesses is the complexity of the
IRS Code and the difficulty of preparing returns.
I conducted a survey in my home district this year, and the
results parallel the Taxpayer Advocate's findings. The most
common complaint was the complexity of the Code and the time
spent preparing returns. More than 40 percent of my
constituents said that they spent more than 10 hours preparing
their taxes, and more than 50 percent said they had to hire a
professional tax preparer. Nationally, the statistics are
similar.
The compliance burden on taxpayers, because of the
complexity of our Code, is truly staggering. Taxpayers spend
more than 5 billion hours and $225 billion annually just to
prepare their returns.
What is even more troubling is a report that shows that
small businesses spend more than $700 in compliance costs for
every $100 of taxes paid. Indeed, doing one's taxes has become
a tax in itself.
Simply put, the Tax Code has become an impediment, and I
think that everyone in this room will agree that this is
unacceptable. Middle-income tax payers are trying to save for
their children's education and their retirement, but struggle
to take advantage of tax laws meant to help them. Small
businesses have propelled the U.S. economy forward in the
nineties and are the primary allies of working Americans in
providing retirement income to support Social Security, but
they continue to worry whether they have complied with arcane
provisions of the Tax Code and pension law. Think of where we
would be today if the Tax Code were not so burdensome.
It is time that Congress tackle this issue head on. I
propose that we start by clearing the underbrush. The Tax Code
is flush with provisions that are obsolete. We should identify
these provisions, with help from the private sector, and wipe
them off the books for good. For instance, there are several
provisions regarding the alternative minimum tax, or AMT as we
call it, that are no longer needed because of changes in the
regular tax. We should get rid of provisions like these and
start cleaning up the Code.
Today, the Subcommittee will focus on some of the more
complex provisions of the Code and explore ways to make them
more taxpayer friendly, especially for middle-income tax payers
and small business owners who are least able to afford
expensive professional help.
On the individual side, we will discuss AMT and the so-
called marriage penalty. On the small business side, we will
discuss expensing and increasing the amount that small
businesses can deduct rather than depreciate.
I am sure that the panelists have identified other
provisions in their written statements that we will not be able
to explore in depth today. Indeed, we have had some come to us
since we prepared this hearing. But today's hearing is an
important first step toward beginning to identify the
underbrush, the deadbeat provisions in the Tax Code, and the
ways in which we could truly move to simplify the Code for
small business and for individual taxpayers in our country.
I'd like to yield to Mr. Coyne, but before I do that, I
want to thank the Joint Committee on Taxation, specifically
Lindy Paull and Mary Schmitt, for their work in identifying
some of the provisions that the Subcommittee will discuss
today, and for their continuing work to develop ideas for us as
we move into taking on the challenge of simplifying the Tax
Code and eliminating obsolete sections.
I'd like now to yield to my colleague, Mr. Coyne.
Mr. Coyne. Well thank you, Madam Chairman. And I want to
thank you for holding today's hearing on a topic that is a
source of concern to millions of Americans, and for your
constant effort to assist and protect America's taxpayers as
they comply with our Nation's tax laws.
This hearing, which will highlight challenges that
individuals and small businesses have in complying with the Tax
Code, is being held as we are about to complete historic
legislation to restructure and reform the Internal Revenue
Service. While most of the IRS reform debate has focused on the
agency's administrative problems, we have devoted too little
attention to the principal reason for the difficulties that the
IRS confronts, namely the complex law that the IRS administers.
As we consider today's testimony on simplifying the Tax Code,
we must remember that our efforts in streamlining and improving
the IRS will be much more successful if we move swiftly to
reduce complexity of tax law.
As we prepare for the next Congress, we must confront the
role that the Code plays in causing compliance headaches for
many individual taxpayers and small businesses. As nearly 2,300
pages make up the Tax Code, with hundreds of forms and
publications, most Americans are intimidated by the Tax Code,
and they fear the consequences of making a mistake. Another
unfortunate result of this complexity is that many Americans do
not take advantage of tax benefits because they either are not
aware of them or do not understand the complicated forms and
instructions.
The debate on fundamental tax reform will continue well
into the next Congress. However, unless and until we agree upon
a replacement, we must fix tax problems with the current Tax
Code by developing simplification measures that are fair and
fiscally responsible. We should consider these alternatives as
soon as possible so that we can provide relief sooner rather
than later for individuals and small businesses.
My colleagues and I on the Ways and Means Committee have
offered measures to reduce complexity and improve tax benefits
for millions of individual taxpayers. Congressman Neal has
introduced a bill, H.R. 4053, that would repeal the overall
limitation on a taxpayer's itemized deductions and phase out
the personal exemption and in doing so, would eliminate two
complex worksheets. Mrs. Kennelly has introduced H.R. 2524,
which would allow the standard deduction and personal
exemptions under the alternative minimum tax as well as permit
nonrefundable credits such as the family tax credit to offset
the minimum tax. The proposal that I introduced would provide
taxpayers with a simple 38-percent exclusion of their capital
gains from taxation, thereby eliminating 35 lines on Schedule
D. I am including for the record a copy of Schedule D, as well
as a description of the several Ways and Means Committee
Members' proposals regarding tax simplification.
[The information is being retained in the Committee files.]
Madam Chairman, while we consider the fundamental direction
of our tax systems over the next several years, we must move
forward on specific measures to simplify the Tax Code. Working
together in a bipartisan basis, this is real relief that our
Committee can provide now for individuals and small businesses.
Thank you.
Chairman Johnson of Connecticut. Thank you, very much, Mr.
Coyne, and I do appreciate the proposals of the Members of the
Ways and Means Committee. And we will be looking at every one
of them in depth. It is really a pleasure to welcome now as our
first--those first to testify. Steve and Anthony Bafundo,
partners in A.J. Bafundo and Co., LLC, in Newington,
Connecticut.
Thank you for being with us.
STATEMENT OF STEVE BAFUNDO, PARTNER, A.J. BAFUNDO AND CO., LLC,
NEWINGTON, CONNECTICUT
Mr. Steve Bafundo. Thank you, Chairman Johnson.
Members of the Subcommittee, my name is Steve Bafundo. I am
a certified public accountant and partner in the Newington,
Connecticut firm of A.J. Bafundo and Co., LLC. Joining me today
is our firm's managing partner, Anthony J. Bafundo.
Our small, local firm consisting of three partners and four
hardworking support staff prepares approximately 800 Federal
tax returns a year and serves well over 200 small businesses
and nonprofit organizations, ranging in annual receipts from a
few thousand dollars to $15 million.
One of my primary responsibilities is to prepare and review
the preparation of our form 1040s. The vast majority of our
individual income tax clients would be described as middle- to
upper-middle-income tax payers, with an average household
adjusted gross income of approximately $60,000.
In my opinion, the most distressing characteristic of our
current Internal Revenue Code is the complexity of tax laws as
they relate to the average American. It is unfortunate that
many common circumstances that relate to the middle-class
taxpayer trigger complex laws that leave the taxpayers confused
and frustrated.
Examples of these are as follows: Taxpayers who rent part
of their homes. These individuals have to deal with
depreciation laws, potential passive activity loss limitations,
and upon sale of the property, complex calculations for
determining gains or losses.
Taxpayers who are sole proprietors. While we do prepare
Schedule Cs for law practices and doctors' offices, the vast
majority of our Schedule Cs are prepared to report income for
more modest ventures that include office cleaning, snow
plowing, home daycare providers, bulk newspaper delivery,
handymen, and other small businesses--many of them second jobs
the individuals perform to make ends meet. These taxpayers must
comply with complicated depreciation calculations, vehicle
usage rules, home office usage rules, self-employment taxes
deductions, and estimated tax calculations, just to name a few.
Retired pensioners who receive Social Security. The
computation of Social Security benefits is an 18-line
computation that is tricky and very difficult to explain.
Taxpayers who invest in mutual funds. For the year ended
December 31, 1997, taxpayers who received even small amounts of
capital gains from their mutual funds were asked to compute a
Schedule D that resulted in a record number of new clients
seeking our assistance.
Other potential complicated tax scenarios challenging the
average American taxpayer include alternative minimum tax, IRA
and other retirement benefits, laws and regulations, and earned
income credit.
[The prepared statement follows:]
Statement of Steve Bafundo, Partner, A.J. Bafundo and Co., LLC,
Newington, Connecticut
Chairman Johnson, Members of the Committee
My name is Steve Bafundo, I am a Certified Public
Accountant and partner in the Newington, Connecticut Public
Accounting Firm of A.J. Bafundo & Company, LLC. Joining me
today is our firm's Managing Partner, Anthony J. Bafundo. Our
small local firm consisting of 3 partners and 4 hardworking
support staff prepares approximately 800 Federal tax returns a
year and serves well over 200 small businesses and non-profit
organizations ranging in annual receipts from a few thousand to
15 million dollars.
One of my primary responsibilities is to prepare and review
the preparation of our Form 1040's. The vast majority of our
individual income tax clients would be described as middle to
upper-middle income taxpayers with an average household
adjusted gross income of approximately $60,000.00. In my
opinion, the most distressing characteristic of our current
Internal Revenue Code is the complexity of laws as they relate
to the average American.
It is unfortunate that many common circumstances that
relate to the middle class taxpayer trigger complex laws that
leave the taxpayer confused and frustrated, examples of these
are as follows:
1. Taxpayers who rent part of their homes.--These
individuals have to deal with depreciation laws, potential
passive activity loss limitations and upon sale of the
property, complex calculations for determining gains or losses.
2. Taxpayers who are sole proprietors--while we do prepare
Schedule C's for law practices and doctors' offices, the vast
majority of our Schedule C's are prepared to report income from
more modest ventures that include office cleaning, snow
plowing, home daycare providers, bulk newspaper delivery,
handyman and many other small businesses, many of them second
jobs, that individuals perform to make ends meet. These
taxpayers must comply with complicated depreciation
calculations, vehicle usage rules, home office usage rules,
self-employment taxes, deductions and estimated tax
calculations just to name a few.
3. Retired pensioners who receive Social Security.--The
computation of taxable Social Security benefits is a 18-line
computation that is tricky and very difficult to explain.
4. Taxpayers who invest in mutual funds--For the year ended
December 31, 1997, taxpayers who received even small amounts of
capital gains from their mutual funds were asked to compute a
Schedule D that resulted in a record number of new clients
seeking our assistance.
Other potential complicated tax scenarios challenging the
average American Taxpayer include Alternative Minimum Tax, IRA
and other retirement benefits, laws and regulations and Earned
Income Credit.
STATEMENT OF ANTHONY J. BAFUNDO, PARTNER, A.J. BAFUNDO AND CO.,
LLC, NEWINGTON, CONNECTICUT
Mr. Anthony Bafundo. I am responsible for the presentation
of small business owner's taxes.
A small business owner does not just face Federal taxes. He
has the following taxes necessary to start and run a small
business: Payroll taxes, including withholding for Federal and
State; sales taxes in Connecticut and most States; Federal and
State corporation income taxes; licensing requirements in most
professions and businesses; and labor law requirements.
From a Federal income tax perspective, the areas where the
small business owner suffer from the complication of the
Internal Revenue Code are: Alternative minimum tax; and
depreciation.
Most small business owners are completely unaware of the
alternative minimum tax.
Tax preferences are the adjustment of the deductions
allowed on the regular tax versus the alternative minimum tax.
The most onerous preference is depreciation. If businessowners
have to prepare financial statements according to generally
accepted accounting principles, GAAP, they must use one method
of depreciation. Then, on their tax returns, they use MACRS,
Modified Accelerated Cost Recovery System, depreciation. And
for the alternative minimum tax, ADR, asset depreciation range,
depreciation. Therefore, for one asset, they must use three
different methods and keep separate schedules for each.
Upon sale or disposition of the asset, they'd have three
different gains or losses.
Small business corporations must also contend with other
types of preferences. With the ACE, adjusted current earnings,
preference, they must add to their alternative minimum taxable
income the difference between the taxable income on their tax
returns versus their financial statements if the financial
statement income is greater than the tax return income. For
example, if John Jones elects to prepare his tax return on a
cash basis, and his financial statement on the accrual basis,
he will more than likely have higher financial statement income
than tax return income because of the accounts receivable due
from his customers. The ACE adjustment was originally passed
because of large corporations having huge profit but no taxable
income.
Small business owners are required not only to have
comprehensive knowledge about their profession or business, but
are also required to be aware of a complicated and cumbersome
tax structure.
Since they do not have the resources of the large
companies, they are at a disadvantage and in most cases cannot
afford the professional advice to prepare their returns
correctly.
In summary, we recognize that many of these tax laws are
created with the best intentions of the American public.
Political compromises often contribute to a complicated and
frustrating Tax Code. It is our belief that it is time to
simplify the way the American public is taxed.
[The prepared statement follows:]
Statement of Anthony J. Bafundo, Partner, A.J. Bafundo and Co., LLC,
Newington, Connecticut
I am responsible for the presentation of small business
owner's taxes.
Small Business Owner's Taxes
1. Taxes necessary to start and run a small business:
a. Payroll taxes--including withholding for Federal and
State.
b. Sales taxes in Connecticut and most states.
c. Federal and State Corporation Income Taxes
d. Licensing requirements in most professions and
businesses.
e. Labor law requirements.
2. From a Federal Income Tax Prospective the areas where
the small business owners suffer from the complication of the
Internal Revenue Code are:
a. Alternative Minimum tax, and
b. Depreciation
Most small business owners are completely unaware of the
Alternative Minimum Tax.
Tax preferences which are the adjustment of the deductions
allowed on the regular tax vs the alternative minimum tax. The
most onerous preference is depreciation. If a business owner
has to prepare a financial statement according to Generally
Accepted Accounting Principles (GAAP) he must use 1 method of
depreciation. Then on his tax return he uses MACRS depreciation
and for the Alternative Minimum Tax ADR depreciation.
Therefore, for one asset you must use three different methods
and keep separate schedules for each.
Upon sale or disposition of the asset, you have three
different gains or losses.
Small business corporation must also contend with other
types of preferences. With the ACE preference they must add to
their alternative minimum income the difference between the
taxable income on their tax returns vs their financial
statements, if the financial statement income is greater than
the tax return income. For example, if John Jones elects to
prepare his tax return on a cash basis and his financial
statement on the accrual basis he will more than likely have
higher financial statement income than tax return income,
because of the accounts receivable due from his clients. The
ACE adjustment was originally passed because of your large
corporations having huge profits but no taxable income.
The small business owner is required not only to have
comprehensive knowledge about his profession or business but is
also required to be aware of a complicated and cumbersome tax
structure.
Since he does not have the resources of the large
companies, he is at a disadvantage and in most cases can not
afford the professional advice to prepare his returns
correctly.
Summary
While we recognize that many of these tax laws are created
with the best intentions for the American public. Political
compromises often contribute to a complicated and frustrating
tax code. It is our belief that it is time to simplify the way
the American public is taxed.
Chairman Johnson of Connecticut. Thank you very much, both
of you. I'm very impressed with the number of issues that you
brought up and the complexity of them. And now I'd like to turn
to Carl Olandt, who is a CPA and runs his own small business,
and his wife, Kathy.
STATEMENT OF CARL R. OLANDT, NEW BRITAIN, CONNECTICUT
Mr. Olandt. Thank you very much, Madam Chairperson.
I'm testifying as a small business owner, an individual
taxpayer, and a professional accountant. For over 25 years,
I've prepared individual and small business tax returns, and I
would like to thank this Subcommittee for allowing me the
opportunity to voice not only my concerns but the concerns of
the taxpayers for whom I prepare income tax returns.
My comments are short, direct, and simple, as I believe the
Tax Code should be. The alternative minimum tax should be
abolished. It is unfair. The current laws enable some taxpayers
with substantial economic income to significantly reduce their
regular tax. The purpose of the AMT is to ensure that these
taxpayers pay a minimum amount of tax on their economic income.
For the good of the Nation and the economy, the government
should continue to encourage individuals and businesses to make
economic investments. This encouragement should be enhanced by
the special tax treatment that has already been established.
The government should not be setting up the special tax
treatment and then come by the way of the back door of the AMT
to recapture taxes.
The worst part of the AMT is that the average taxpayer
doesn't even realize when they may be subject to the tax. The
instructions are 8 pages long and are extremely complex.
According to the Internal Revenue Service, the average time for
recordkeeping, learning about the AMT law or form, and
preparing the form requires 5 hours and 56 minutes. And this
estimated time only applies to the individual who can
understand both the complexity and the language of the form.
The instructions refer to certain home mortgage interest,
refund of taxes, investment interest, depreciation, adjusted
gains and losses, and numerous other items. How many people
today understand exactly what this means unless they're a
professional accountant? For example, a person who bought
property or invested throughout the years and now sells this
property or investments at a profit in a year with very low
other income may become subject to the AMT without even
realizing it, when there is no regular tax due.
Most professional and tax accountants, as myself, struggle
with the preparation of the form and we usually rely on our
professional computer tax package to alert us to when the form
is required and for help with its preparation. Think about the
individual who must complete this form without the aid of an
accountant or a computer income tax package. This creates
confusion and a genuine hardship on individuals.
I would like to make some comments on depreciation, which
includes computer software.
The depreciation tables should be reviewed to reduce the
depreciable time the Internal Revenue Service has set up to a
more realistic time schedule. Computer software should be
considered a consumable product and be allowed to be expensed
at the time of purchase. This puts into effect the true expense
paid out against income in the appropriate tax year.
Most small businesses purchase software programs tailored
to their business as part of a computer package. This requires
the business to depreciate the computer and software over a 5-
year period. If software is purchased separately, it is
required to be depreciated over a 3-year period. One major
problem is that many businesses cannot keep a computer 5 years
and remain current. Both the computer and the software must be
continually upgraded to meet the ever-changing business needs.
Most software programs do not even operate 3 years without
requiring frequent upgrades. A specific example is my own tax
program, which must be upgraded or replaced every year to keep
current with the ever-changing Internal Revenue Service tax
laws. By forcing businesses to depreciate software over a 3-
year period, a negative effect is created in the year of the
software purchase because business now must pay money--must pay
tax on money they have already expended.
Both my clients and I believe the Internal Revenue Service
should get the appropriate taxes due. But the tax law should
encourage business to expand and improve, and should not make
operating a business a tax hardship. There needs to be better
coordination of business needs and taxes.
In closing, it is my belief that the Tax Codes do not need
to be thrown out. A whole new tax system does not need to be
developed. A flat tax system is definitely unfair to the
majority of taxpayers. The income tax laws as presently written
do contain many inequities, as so stated by Madam Chair and her
esteemed colleague, Congressman Coyne. By reviewing the Tax
Codes and incorporating common sense and simplicity, we can
achieve a system that is acceptable for individuals and
business alike.
Thank you.
[The prepared statement follows:]
Statement of Carl R. Olandt, New Britain, Connecticut
Honorable Congressional Committee Members.
I am testifying as a small business owner, an individual
taxpayer, and a professional accountant. For over twenty-five
years I have prepared individual and small business tax
returns. I would like to thank the Committee for allowing me
the opportunity to voice not only my concerns but also the
concerns of the taxpayers for whom I prepare income tax
returns. My comments are short, direct and simple as the tax
code should be.
1. The Alternative Minimum Tax--Individuals. Form 6251
The alternative minimum tax should be abolished because it
is unfair. The current laws enable some taxpayers with
substantial economic income to significantly reduce their
regular tax. The purpose of the AMT is to ensure that these
taxpayers pay a minimum amount of tax on their economic income.
For the good of the Nation and the economy the government
should continue to encourage individuals and businesses to make
economic investments. This encouragement should be enhanced by
the special tax treatment that has already been established.
The government should not be setting up the special tax
treatment and then come in the back door, by way of AMT, to
recapture taxes.
The worst part of the AMT is that the average taxpayer
doesn't even realize when they may be subject to this tax. The
instructions are eight pages long and are extremely complex.
According to the Internal Revenue Service, the average time for
record keeping, learning about the AMT law or form and
preparing the form requires five hours and fifty-six minutes.
This estimated time applies only to the individual who can
understand both the complexity and the language of the form.
The instructions refer to certain home mortgage interest,
refund of taxes, investment interest, depreciation, adjusted
gain or loss, incentive stock options, passive activities and
tax exempt interest. How many people understand this? For
example, a person who bought property or invested throughout
the years and now sells this property or investments at a
profit in a year with very low other income may become subject
to the AMT without even realizing it, when there would be no
regular income tax due.
Most professional accountants and tax consultants, as I
myself, struggle with the preparation of this form and usually
rely on their professional computer tax package to alert them
to when the form is required and for help with its preparation.
Think about the individual who must complete the form without
the aid of an accountant or a computer income tax package. This
creates confusion and a genuine hardship on individuals.
2. Small business expensing. Depreciation which includes computer
software.
The depreciation tables should be reviewed to reduce the
depreciable time the Internal Revenue Service has set up to a
more realistic time schedule. Computer software should be
considered a consumable product and be allowed to be expensed
at the time of purchase. This puts into effect the true expense
paid out against income in the appropriate tax year.
Most small businesses purchase software programs tailored
to their business as part of a computer package. This requires
the business to depreciate the computer and software over a
five year period. If software is purchased separately it is
required to be depreciated over a three year period. One major
problem is that many businesses cannot keep a computer five
years and remain current. Both the computer and software must
be continually upgraded to meet ever changing businessoftware
programs do not even operate three years without requiring
frequent upgrades. A specific example, is my own tax program
which must be upgraded or replaced every year to keep current
with the ever changing Internal Revenue Service tax laws. By
forcing business to depreciate software over a three year
period a negative effect is created in the year of the software
purchase, because business now has to pay tax on money they
have already expended.
As previously stated the depreciation tables are not
realistic. For example, a new roof on residential rental
property as required by the Internal Revenue Service law must
be depreciated over 27.5 years. There are not many roofs built
today that can last that long. Most roofs are only guaranteed
form 5 to 15 years. The depreciation tables by not being
realistic discourages many businesses from investing in
equipment as often as they would normally do.
3. Section 179, first year expensing for small business.
The section 179 deduction should be increased
substantially. Due to the high cost of purchasing most
equipment, the current allowable deduction of $18,000.00 is not
sufficient. By increasing the allowable amount of deduction
business will be encouraged to expand and upgrade their
equipment more frequently.
Many new businesses are not aware that they will not get
full credit for the money they have expended for new equipment
or starting a business. This places a major strain on business
to pay out money for new equipment and still be able to cover
required taxes. At tax year end, business now owes taxes on
money they have used to purchase new equipment. This situation
has caused many businesses to owe substantial tax money to
Internal Revenue Service. In many cases business is forced to
buy on the installment basis so they can maintain sufficient
money to cover the taxes, ultimately the end result is business
pays more money in interest and fee charges.
Both my clients and I believe the Internal Revenue Service
should get the appropriate taxes due, but the tax laws should
encourage business to expand and improve and should not make
operating a business a tax hardship. There needs to be better
coordination of business needs and taxes.
In closing it is my belief that the tax codes do not need
to be thrown out. A whole new tax system does not need to be
developed. A flat tax system is definitely unfair to the
majority of taxpayers. The income tax laws as presently written
do contain many inequities. By reviewing the tax codes and
incorporating common sense and simplicity, we can achieve a
system that is acceptable for both individuals and business
alike.
Chairman Johnson of Connecticut. Thank you very much, Carl.
Mr. Evanich.
Mr. Evanich. Evanich.
Chairman Johnson of Connecticut [continuing]. Member of the
Board of Governors and member of the Federal Tax Division,
Connecticut Society of Certified Public Accountants.
STATEMENT OF JOHN L. EVANICH, JR., CERTIFIED PUBLIC ACCOUNTANT,
MEMBER, BOARD OF GOVERNORS, AND MEMBER, FEDERAL TAX DIVISION,
CONNECTICUT SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS,
WALLINGFORD, CONNECTICUT
Mr. Evanich. Good afternoon, Madam Chairman, and Members of
this distinguished Subcommittee. We, the Connecticut Society of
CPAs, appreciate this opportunity to testify today on the
individual alternative minimum tax, the marriage penalty, and
the section 179 expensing deduction. My name is John Evanich,
and I'm a certified public accountant from Connecticut. I'm a
member of the Board of Governors of the Connecticut Society of
CPAs and a member of their Federal Tax Division. I'm also a
member of the American Institute of CPAs and their tax
division.
The Connecticut Society of CPAs currently has over 6,600
members, many of whom are in public practice or otherwise
prepare tax returns for many thousands of individual taxpayers
and small businesses. Accordingly, we see firsthand many horror
stories of taxpayers caught in the tangled web of tax law
complexities and the unexpected traps of certain provisions of
the tax laws. These complexities and traps cause taxpayers to
lose faith in the tax system in general and in their ability to
understand the tax consequences of otherwise straightforward
transactions.
The three issues that I will be addressing involve concerns
of complexity in the Tax Code, but they also involve concerns
of fairness in our tax laws. As we all know, there are often
unexpected consequences of well-intentioned tax provisions.
These need to be continually sought out and corrected,
particularly in light of continuing complexity of these same
tax provisions.
As I said, I will briefly discuss three tax issues
affecting middle-income individuals and small businesses, all
of which are a concern to the Connecticut Society of CPAs.
Namely, I would like to explain our concerns with the AMT, the
marriage penalty, and the section 179 expensing deduction.
The alternative minimum tax, first. As you know, our tax
laws contain many provisions allowing special treatment for
certain types of income and gains, and special deductions for
expenses and losses if certain rules are met. In the past,
these tax laws allowed some taxpayers to pay little or no
income tax, even though they may have received substantial
economic income. Through passage and subsequent expansion of
the alternative minimum tax, many more of these taxpayers now
pay at least a minimum of tax on their economic income.
Unfortunately, in order to accomplish this goal, the AMT
rules have become increasingly complex. In fact, the AMT is one
of the most complex provisions in the tax system. The many
items of preference and adjustment, which must be calculated in
order to determine the taxpayers' AMT liability, are extremely
complex, and many require a taxpayer to keep detailed and time-
consuming records of assets and transactions. In effect,
taxpayers must keep two complete sets of books, one for regular
tax purposes and another for AMT purposes.
Furthermore, many of the provisions of the Taxpayer Relief
Act of 1997, while each accomplishing its intended benefit,
also cause some unexpected results.
First, many of the technical AMT tax provisions were
actually made more complex. And second, many more individual
taxpayers will now be subject to the AMT. In fact, many
taxpayers who will not actually pay the AMT, must still keep
these detailed records just to correctly determine which tax
they are to pay--the regular income tax or the AMT tax.
Further complicating this situation is the increasingly
complex nature of these provisions, as already mentioned. With
a significant increase in the number of taxpayers subject to or
potentially subject to the AMT, there will now be many less
sophisticated taxpayers expected to be aware of and understand
these provisions. Since an increasing number of these middle-
class taxpayers, who will now be subject to the AMT, may
currently prepare their own tax returns, either manually or
using consumer type tax preparation software, and since in many
cases the AMT cannot correctly be calculated from information
directly used in preparing these returns, there's a
significantly increased chance that taxpayers subject to the
AMT will not correctly calculate and pay this tax. Needless to
say, this will add significant further enforcement efforts to
the responsibilities of an already overburdened Internal
Revenue Service.
The Connecticut Society of CPAs strongly recommends that
consideration be given to simplifying the AMT provisions as
they're now written so that an average taxpayer would have at
least a fair chance of understanding this tax and correctly
preparing their own tax return each year.
Furthermore, we suggest these rules be modified to provide
an exemption from the AMT for certain taxpayers with income
below certain thresholds and with only certain specific
preferences or adjustments.
If it's OK, I'm going to skip some of the details since I'm
out of time. I would like to mention, if I could take another
minute, the marriage penalty provisions.
Those are a significant concern. In effect, what they do
is, the tax laws are causing people to either postpone getting
married or actually consider divorce simply for purposes of tax
saving.
In addition, the last item I have, the section 179
expensing deduction, while the expense allowance is being
increased each year, from currently $18,500 to eventually
$25,000, there's a reduction limitation if a taxpayer spends
over $200,000 a year in total equipment costs. That $200,000
limitation hasn't been increased at all since it was first
enacted in 1986. And again, the Connecticut Society of CPAs
recommends that that be increased or eliminated entirely.
The Connecticut Society of CPAs is honored to be invited to
appear before this Subcommittee to present our views on certain
tax provisions needing modification in the interest of
simplification and fairness. We thank you for this opportunity
and stand ready to work with you on these or any other tax
provisions under consideration.
Thank you.
[The prepared statement follows:]
Statement of John L. Evanich, Jr., Certified Public Accountant, Member,
Board of Governors, and Member, Federal Tax Division, Connecticut
Society of Certified Public Accountants, Wallingford, Connecticut
Introduction
Good afternoon, Madam Chair, and members of this
distinguished Subcommittee. We appreciate this opportunity to
testify today on the individual alternative minimum tax (AMT),
the ``marriage penalty,'' and the ``Section 179 Expensing
deduction.'' My name is John Evanich, and I am a Certified
Public Accountant from Connecticut. I am a member of the Board
of Governors of the Connecticut Society of CPAs, and a member
of their Federal Tax Division. I am also a member of the
American Institute of CPAs and their Tax Division.
The Connecticut Society of CPAs currently has over 6,600
members, many of whom are in public practice or otherwise
prepare tax returns for many thousands of individual taxpayers
and small businesses. Accordingly, we see first-hand many
horror stories, of taxpayers caught in the tangled web of tax
law complexities and the unexpected traps of certain provisions
of the tax laws. These complexities and traps cause taxpayers
to lose faith in the tax system in general, and in their
ability to understand the tax consequences of otherwise
straightforward transactions.
The three issues that I will be addressing involve concerns
of complexity in the tax code, but they also involve concerns
of fairness in our tax laws. As we all know, there are often
unexpected consequences of well-intentioned tax provisions,
these need to be continually sought out and corrected,
particularly in light of continuing complexity of these same
tax provisions.
As I said, I will briefly discuss three tax issues
affecting middle-income taxpayers and small businesses, all of
which are of concern to the Connecticut Society of CPAs.
Namely, I would like to explain our concerns with the
Alternative Minimum Tax, the ``marriage penalty,'' and the
``Section 179 Expensing Deduction.''
Alternative Minimum Tax
As you know, our tax laws contain many provisions allowing
special treatment for certain types of income and gains, and
special deductions for expenses and losses if certain rules are
met. In the past, these tax laws allowed some taxpayers to pay
little or no income tax, even though they may have received
substantial economic income. Through passage and subsequent
expansion of the alternative minimum tax (AMT), many more of
these taxpayers now pay at least a minimum amount of tax on
their economic income.
Unfortunately, in order to accomplish this goal, the AMT
rules have become increasingly complex. In fact, the AMT is one
of the most complex provisions in the tax system. The many
items of ``preference'' and ``adjustment'' which must be
calculated in order to determine a taxpayer's AMT liability are
extremely complex, and many require a taxpayer to keep detailed
and time consuming records of assets and transactions. In
effect, taxpayers must keep two complete sets of records--one
for ``regular'' tax purposes and another for ``AMT'' tax
purposes.
Furthermore, many of the provisions of the Taxpayer Relief
Act of 1997, while each accomplishing its intended benefit,
also cause some unintended results--first, many of the
technical ``AMT'' tax provisions were actually made more
complex, and second, many more individual taxpayers will now be
subject to the AMT. In fact, many taxpayers who will not
actually pay the AMT, must still keep these detailed records,
just to correctly determine which tax they are to pay--the
``regular'' income tax or the ``AMT'' tax.
Further complicating this situation is the extremely
complex nature of these provisions, as already mentioned. With
a significant increase in the number of taxpayers subject to
(or potentially subject to) the AMT, there will now be many
less-sophisticated taxpayers expected to be aware of and
understand these provisions. Since an increasing number of
these middle-class taxpayers who will now be subject to the AMT
may currently prepare their own tax returns (either manually or
using consumer-type tax preparation software), and since in
many cases the AMT cannot correctly be calculated from
information directly used in preparing these returns, there is
a significantly increased chance that taxpayers subject to the
AMT will not correctly calculate and pay this tax. Needless to
say, this will add significant further enforcement efforts to
the responsibilities of an already overburdened Internal
Revenue Service.
The Connecticut Society of CPAs strongly recommends that
consideration be given to simplifying the AMT provisions as
they are now written, so that an ``average'' taxpayer would
have at least a fair chance of understanding this tax, and
correctly preparing their own tax return each year.
Furthermore, we suggest that these rules be modified to
provide an exemption from the AMT for certain taxpayers, with
income below certain thresholds or with only certain specific
``preferences'' or ``adjustments.'' For example, taxpayers with
only itemized deductions and personal exemptions shouldn't be
paying the AMT at all. Likewise, taxpayers who qualify for
either the new ``Child Tax Credit'' or ``Education Tax
Credits'' shouldn't find themselves giving this tax break back,
in the form of an AMT.
There are many other ways that the AMT provisions can be
modified to be more ``user-friendly'' for middle-class
taxpayers, so that only those taxpayers originally intended to
be subject to the AMT--those with large economic income and
little or no regular income tax--will again be subject to both
the tax itself and the burdensome recordkeeping requirements of
these provisions.
Marriage Penalty
Under the current tax system, both a ``marriage penalty''
and a ``marriage bonus'' exist. A ``marriage penalty'' occurs
when two married individuals have a greater tax liability when
compared to two similarly situated single individuals. A
``marriage bonus'' occurs when the opposite result ensues B two
married individuals paying a lower tax liability than two
similarly situated single taxpayers. In nearly all cases,
current tax laws result in a ``marriage penalty,'' meaning that
spouses with separate incomes usually will pay a higher tax
than they would pay if they were allowed to file as single
taxpayers. It has been estimated that about two-thirds of all
married couples pay more income taxes than they would if they
divorced!
Furthermore, tax complexity has again created an unbearable
situation for many taxpayers. There are at least 63 provisions
in the Internal Revenue Code where tax liability depends on
whether a taxpayer is married or single. Many of these
differences were originally created to be fair, to target
benefits to specific taxpayers, or to prevent abuses of
specific provisions. The Taxpayer Relief Act of 1997 added even
more complexity in this area, specifically in the provisions
regarding the Child Tax Credit, Education Tax Credits and other
tax incentives for education, and even Roth Individual
Retirement Accounts to name just a few!
Furthermore, there is now an ever-increasing list of tax
provisions tied to some level of Adjusted Gross Income (AGI) or
Modified AGI. Since nearly all of these AGI-controlled
provisions impose a further ``marriage penalty'' on married
taxpayers, the ``penalty'' continues to grow.
The Connecticut Society of CPAs strongly recommends that
consideration be given to eliminating the ``marriage penalty.''
This would result in a more fair and equitable tax system, one
in which marital status would not affect the amount of taxes
paid by two similarly situated individuals. In addition,
elimination of the ``marriage penalty'' would result in
simplifying the tax laws, meaning that an ``average'' taxpayer
would again have at least a fair chance of understanding their
income tax, and correctly preparing their own tax return each
year. Finally, the government would no longer be viewed as
discouraging taxpayers from remaining married, or from getting
married in the first place!
Also, consideration should be given to simplifying the
calculation of a couple's income tax liability, by eliminating
many of the AGI-controlled limitations and phase-outs. In this
way, taxpayers will feel two immediate benefits B simplified
tax laws that they have a greater chance of understanding, and
increased faith in the fairness of our overall tax system.
Section 179 Expensing Deduction
Since 1982, small businesses have been allowed to elect to
deduct currently, instead of depreciating over several years,
the cost of certain qualifying property purchased for use in
their business. Although originally limited to $5,000 of cost
per year of such property, this annual limit has been increased
several times over the past 16 years. The Section 179
limitation ($18,500 for 1998) is currently in the midst of
scheduled increases, and will eventually reach a maximum annual
deduction of $25,000 by year 2003.
However, since 1986, this tax benefit also has a specific
limitation imposed on it. In order to qualify for the maximum
deduction under this provision, a taxpayer cannot have
purchased more than $200,000 of total qualifying property
during the tax year. For each dollar of property purchased in
excess of this $200,000, the Section 179 deduction is reduced
by one dollar.
This reduction if property is acquired in excess of
$200,000 was added by the Tax Reform Act of 1986.
Unfortunately, while the annual deduction under Section 179 has
been increased several times since 1986, this ``reduction
limitation'' has not increased at all during these past twelve
years.
Since prices of equipment and other property have almost
certainly increased since 1986, this limitation has actually
discouraged certain taxpayers from purchasing new property if
they are at or near this limitation. While other tax provisions
are intended to encourage businesses to reinvest in new
equipment and other property, this provision may often have the
unintended result of actually discouraging such investment.
The Connecticut Society of CPAs strongly recommends that
consideration be given to eliminating the ``disincentive'' that
may result from this Section 179 ``reduction limitation.'' In
order to encourage all businesses to invest in qualifying
property, and as a further step toward simplification,
consideration should be given to the complete elimination of
this ``reduction limitation.'' Alternatively, consideration
should at least be given to increasing the dollar threshold,
over the same period as the current schedule of deduction
increases, in order to at least not reduce or eliminate the
potential benefits of this increase for many small businesses.
Furthermore, this would result in a more fair and equitable
tax system, since all capital-intensive businesses would be
able to take advantage of this deduction on an equal basis,
regardless of the amount spent on qualifying property purchased
in any one tax year. Finally, the elimination of this
``reduction limitation'' would also eliminate the necessity of
small businesses postponing their purchase of necessary
equipment, merely because they have maximized their qualifying
purchases for the current year.
Conclusion
The Connecticut Society of CPAs is honored to be invited to
appear before this Subcommittee, to present our views on
certain tax provisions needing modification in the interest of
simplification and fairness. Although we believe that there are
many provisions of the tax law that can be improved, these
three specific provisions are of particular concern for all
middle-income individuals and small businesses.
We thank you for this opportunity, and stand ready to work
with you on these or any other tax provisions under
consideration. We believe that ``Tax Simplification'' and an
improved level of ``fairness'' in our tax system is in the best
interest of the entire country. Thank you for taking the time
to hear our concerns.
Chairman Johnson of Connecticut. I thank you all for your
input. I found it extremely interesting, and let me ask first,
how do you as preparers keep up in the changes? What does it
take to be out there as a CPA advising people on tax law in
today's world?
Mr. Olandt. Madam Chairperson, for myself, I subscribe to
four professional tax accounting organizations and receive
their monthly newsletters, and study them, scrutinize them
every month for the changes and their explanation. And numerous
times after IRS comes out with some policy direction even what
our, such as the National Society of Accountants and other
organizations have given their interpretation to it, it
becomes--they rechange it when they send it to you to reexplain
it to you so that it keeps us very much on our toes.
Chairman Johnson of Connecticut. Mr. Bafundo.
Mr. Anthony Bafundo. Well, we do it from three sources.
First, we attend seminars given. Second, we have tax services
that provide monthly updates. And third, we also have in-house
seminars where we take a section of the Code and explain it to
the rest of the staff. And we also send around certain changes
that they have to read--we get a weekly change. And we make
sure that every staff member signs off that they've read the
changes for that particular week.
Chairman Johnson of Connecticut. You mentioned, Mr. Steve
Bafundo, in your testimony the difficulty for taxpayers who
rent part of their homes. I assume you're thinking about the
residences that are common in Connecticut--two families, three
families, situations like that. Is there--and this actually
goes to a number of aspects of each of our testimony. As in
other parts of the law, and in the individual Code, we
recognize the need to exempt low-income filers from complexity.
Is there a need to exempt, to make, to draw some different
lines, on who is going to be affected by what? And if you were
going to do that, for instance, at what income would you want
to exclude people from the AMT--simplify the law in regard to
rental--in an owner-occupied building?
Mr. Steven Bafundo. Well, first of all Congressman Johnson,
you know that your own hometown of New Britain is filled with
multifamily houses, and we do a heck of a lot of New Britain
residents' tax returns. Most of these individuals don't make
over $50,000 a year. They're working-class families, and yet
they are dealing with complex depreciation issues. In certain
cases, the passive activity losses could come in if their
income goes a little higher. But certainly they have to take a
look at those forms.
And the only conclusion I draw is that when these laws were
made up for rental properties, the assumption was that whoever
wrote the laws figured that either everybody who had a rental
property was going to a tax preparer, or they had access to a
computer to be able to do those kind of computations. I think
there should be some kind of differentiation as to whether you
rent out a portion of your principal residence versus somebody
that has a 10-unit apartment building. I think that you could
clearly make things a lot easier for individuals to rent out
the second floor, or maybe the second and third floors, and yet
occupy that property. There's a lot of people that have to pay
a fair sum of money to have their returns prepared solely
because they rent out a portion of their house, something
that's necessary for them to do to make ends meet.
Chairman Johnson of Connecticut. A similar issue that you
raised in regard to sole proprietors, you know, people who have
a part-time business or really are a small sole proprietor.
When you enumerate the things that they have to take into
account, would it be useful to consider an alternative single
deduction that you could choose rather than enumerating all of
these?
Mr. Steve Bafundo. That would be great. I know a couple of
years ago, there was an effort made to make it a little
simpler, with the form C-EZ that was put in. But that doesn't
really exempt them from the different considerations that they
do have. For example, the vehicle usage, home office--if they
have home office--and some of the other depreciation aspects.
These--it would be tough to come up with a standard deduction
per se for a small business owner, but maybe that's something
that you consider. The problem is that some of these small
businesses--so many of them are so different--have different
needs or different ways of doing business--that I don't know if
you could come up with a standard. But it would be something to
look at, because, once again, there's a lot of people that make
very little money that need our services because they're up at
4 o'clock in the morning shoveling or plowing driveways, or
they're delivering bulk newspapers. I'm giving you real-world
examples. Or maybe they pick up a few thousand dollars during
the year cleaning somebody's office at night. And yet these
people have to pay hundreds of dollars to get their tax returns
done, because they can't figure it out for themselves.
Mr. Anthony Bafundo. Well, there's also another
consideration: Self-employment tax. Somebody who makes $2,000,
they may not pay any income tax, but they're subject to Social
Security, so they have to file a tax return even though they
don't owe Federal income tax.
And the second thing, sometimes we run across elderly
people who own a house and rent a second floor, and they
really--the only thing they have is the Social Security and the
rent they get from the home. And when you figure out their tax,
it's zero income tax. But they have to file a return because of
taking taxable income into consideration when you file a
return, you have to take gross income subject to taxation. So
these people may have a rental property where they collect
$10,000 a year, and they're 70 years old, and they still have
to file a tax return, even though they have no tax to pay. And
most of these people are not in the best of financial shape.
Chairman Johnson of Connecticut. On the alternative minimum
tax, let me just run down for you a couple of the suggestions
that our tax staff has made and get your opinion as to whether
this would be very--it would be helpful or not. Some of it may
not pertain to the sizes of businesses that you deal with, but,
for instance, we could repeal provisions that, in fact, are
obsolete that relate to passive losses, R&D expenses,
circulation expenses, farming losses, mining exploration,
development expenses, long-term contracts, and pollution
control facilities. Most of that wouldn't pertain to most of
the small businesses you deal with, except the passive losses.
Would that make any difference?
Mr. Anthony Bafundo. The----
Chairman Johnson of Connecticut. There are some others so
you can----
Mr. Anthony Bafundo. We do quite a few contracting
companies. Well, the long-term contract provisions where they
have to--we use sometimes cash basis or percentage of
completion.
Chairman Johnson of Connecticut. In other words, if we
excluded that, that would be helpful?
Mr. Anthony Bafundo. Right, that would be helpful. Yes.
Chairman Johnson of Connecticut. What about coordinating
certain provisions of the AMT with regard to regular tax, such
as providing for the regular tax 7.5-percent AGI floor, rather
than the alternative minimum tax 10-percent floor for medical
expenses. You know, if we align to these things, would that
make that easier?
Mr. Anthony Bafundo. Yes. Definitely. Especially medical.
If somebody has medical expenses, normally they need the help.
If they have to go over 7\1/2\ percent of their adjusted gross
income, they probably have a similar amount of medical expenses
and are in poor shape financially.
Chairman Johnson of Connecticut. And then, one of the
things that we've discussed quite extensively is allowing
deductions under the AMT for items not generally considered to
be tax preferences, such as employee business expenses and
investment expenses; that those would not be--they would not
come under the AMT.
Mr. Anthony Bafundo. Yes, that makes sense.
Chairman Johnson of Connecticut. I am interested as you go
home and sort of think about this, as you--you know, the more
you can help us come up with specific ideas as to how to
simplify and give us some ideas as to if we do this, how many
does that help? Are you seeing a lot of individuals now coming
into the alternative minimum tax system? Are you seeing more
coming in now than you did 2 or 3 years ago?
Mr. Evanich.
Mr. Evanich. Yes, Madam Chairman. Definitely more, and
there will be significantly more as the provisions of the
Taxpayer Relief Act of 1997 take effect. We're going to, for
the first time, have taxpayers realizing that they're thinking
they're getting an education tax credit or a child tax credit,
but then finding out that they're giving it right back in the
form of an AMT, and that's going to hit this year when they
file their returns.
Chairman Johnson of Connecticut. This year?
Mr. Evanich. Yes.
Chairman Johnson of Connecticut. I'd be interested in what
you--what you--what change you think we need to make in the
threshold to stave that off. We are looking at the possibility
of excluding those expenses, allowing those preferences before
the AMT hits. But it would be interesting to know what the--how
you would have to lift the threshold in order to avoid denying
people the benefits that we just gave them.
Mr. Coyne.
Mr. Coyne. Thank you, Madam Chairman. I would like to yield
to Mrs. Thurman.
Mrs. Thurman. I'd like to thank the gentleman.
I really want to focus on one issue because many of us have
been doing some hearings for the last couple of weeks under
guidance of the Chairman, Nancy Johnson, and the year 2000
issue. And I noticed in much of the testimony--or in some of
the testimony today specifically you talked about some small
business expensing and depreciation, including computer
software. One of the things that we're concerned about is what
are small businesses going to do out there while we're trying
to worry about government, we're worried about how they're
going to network and how they're going to interact without
getting--because we need to get 2000 done.
Can you give us some ideas of some kinds of things that
might promote to businesses or particularly to small businesses
in the Tax Code that would maybe get them to kind of jump into
this or at least see something in the Tax Codes that would help
them get to this problem?
Mr. Evanich. Congresswoman, I'd like to answer that. Yes,
first of all in the section 179 expensing deduction area,
elimination of the $200,000 a year limitation, where you start
to lose a dollar for every dollar that you spend over that,
would allow all businesses to spend whatever they truly need to
spend to purchase equipment without worrying about artificial
limitations; so that we tax advisors don't sit with them in the
11th month, and say, no, don't buy any more equipment this
year, wait until next year. They can truly buy what is right
for their business. It's very easy to hit $200,000 nowadays.
Mrs. Thurman. Would it be, I mean could we do it in a way
that we could just keep it for a short period of time because
this is an immediate problem? And so, say, we said that if you
do it in 1998, 1999, obviously, because we have to worry about
how we would pay for all of this--I mean, I think, you know,
we're trying to figure out the best way to do this. We've done
some research and it says that, you know, I guess you could
take some because of repair. Because there's a part of the Code
that you could actually use this as a repair tax credit. I've
tried to look at depreciation. I've tried to look at some other
areas that I'm just trying to get these people motivated out
there, because we are really concerned about what's going to
happen when they don't have the equipment available. I mean is
that--I mean, I know that kind of makes everything crazy in the
Tax Code, but even if we limited it for a short period of time
based on whatever money amount we needed. I mean, that's going
to be our big issue.
Mr. Evanich. Yes, unfortunately that is just bringing in
one more element of complexity into----
Mrs. Thurman. I know.
Mr. Evanich [continuing]. What's already unbearable.
Mrs. Thurman. And I really don't want to do that. That's a
problem for me, but at the same time, I don't know how long you
could continue that for a long period of time and what the cost
of that would be. And, of course, we have to offset any
expenditures that we have, and trying to find a replacement for
that, depending on whatever--you know, it would be what the Tax
Committee would come back with as the amount of dollars. And
that could be huge, I suppose.
Mr. Steve Bafundo. If I could address this for 1 second.
The cost of computers these days, with the turnover in
technology, is such that I believe if you did something maybe
even permanently, but especially in light of the Y2K problem, I
think it would be a tremendous savings to people if you could
take electronic data processing type of equipment and maybe put
on a special writeoff of some sort to encourage people to stay
current. Without their computers, you know, one of the problems
they have is they're not able to keep up with their accounting
systems and with their tax preparation. So I think you would be
helping people if you did something special with EDP type of
deductions or writeoffs.
Mr. Anthony Bafundo. Right now, they're 5 years, so, you
know, if you could have 3-year or a 2-year writeoff, or a
complete writeoff, even though it is complicating the law.
Mr. Olandt. It would definitely help if you gave special
exemption to the data processing part of it because every
business is going to have to replace or readjust for the year
2K. And if you gave them just a flat exemption in that area,
that would allow them to move into year 2K with their business
and have everything correct to date. And for the amount that it
would be based on the computer part or industry, I don't
believe would cost the Federal Government that much money.
Mrs. Thurman. OK. You want to add. You looked like you were
ready to add something there?
Mr. Anthony Bafundo. Well, the computers, by their nature,
do depreciate. Five years is practically infinity.
Ms. Thurman. I did notice that in the testimony that there
seems to be some consensus that this is an area. Quite frankly,
in talking to my CPAs at home when I first ran for Congress,
they told me the one thing you can do in business is to help
them through some of their tax credits. That being one of them
and, of course, we did some of that in 1993 where, I guess, we
jumped up to about $17,000 in equipment. They said the same
thing that was the one thing you could do to keep them fueled
and running. So it seems pretty consistent. I will say that I
think all of us agree on the AMT. I hear it from everybody.
That is just a nightmare out there.
There's another issue and I found this as an interesting
one and I'm talking about because my Chairman is on the phone.
But when I talked to my accountants this year, they told me on
the capital gains issue--which seems to have gotten some
attention--actually they have a different opinion. They said
this first year was a nightmare because it was new and it was
complicated and those kinds of things. But they kind of told me
that after this year getting through this that it probably was
not a big deal. I mean, you can agree or disagree.
Mr. Olandt. Well, I tend to agree that for the accountant
it's not a big deal and especially as we get more used to its
items. But for the individual taxpayer, you've set up 10
percent--20 percent--25 and 28 percent, but the individual
taxpayer really doesn't understand all this. For the majority--
especially for about the 55 people that had capital gains--or
60 returns that I did, they in essence only saved somewhere
around $30, $40. So we--but yet had to pay the accountant $15,
$20, $25 to prepare that 1-page return. In fact, many of us
experienced the whole--a whole bunch of new clients strictly
because of the capital gains. I mean, it did a lot to help us
accountants but didn't do anything for the poor middle-class
taxpayers.
Ms. Thurman. But would that change even if we took it back
to 12 months versus 18? Or is it just the whole issue of the
rules and regulations that went with it?
Mr. Olandt. It's the whole issue of the rules and
regulations----
Ms. Thurman. But not the month of the time period in which
you hold it.
Mr. Olandt. Right. That's part of the problem is they're--
--
Ms. Thurman. OK.
Mr. Olandt [continuing]. Keeping the complexity of paying
attention to the direct buy and sell date which they have to do
anyway. But the fact that it's so complicated and they have to
take it off the regular tax and they have to compute at what
level of tax it is. For the savings at the end, they look at a
lot of work for not a lot of that kind of money.
Mr. Evanich. The Connecticut Society of CPAs, as a public
service for our two largest newspapers in Connecticut, man the
telephones during tax seasons for their readers to call in with
questions.
Ms. Thurman. Bless them. [Laughter.]
Mr. Evanich. I think we did for 3 nights altogether--4
nights altogether. About 80 percent of the questions that we
got revolved around capital gains and losses and sale of
residence. Unfortunately with five different rates for capital
gains and potentially five different AMT capital gains rates,
the average taxpayer--especially trying to prepare their own
returns--just doesn't have a chance of understanding.
Ms. Thurman. OK. Well, thank you.
Chairman Johnson of Connecticut. Very sobering. I wanted to
pursue this issue of expensing a little bit further. For years,
the Committee has tried to increase the expensing threshold.
How useful is that? At what level do you think expensing ought
to be at? Software is becoming really, in a sense, a normal
business expense now. Should that even be included in the
expensing provisions or should it be limited to the hardware--
to the computers and other equipment? So one is the level and
second whether software should still be part of it.
Mr. Olandt. Madam Chairman, I would say that the software
itself should be just taken as a consumable product as I
submitted in my written testimony.
Chairman Johnson of Connecticut. As a business expense?
Mr. Olandt. As a business expense, yes. A lot of
businesses, as I said, get tailored software to their
businesses. If you're a contractor and you're trying to keep up
with the materials, you're buying a package every year that
gives roughly prices and they upgrade it semiannually usually.
A lot of the contractors that I have, on their laptop
computers, will upgrade their pricing so that when they go out
and give a bid on producing a job, doing a home improvement,
building an addition--they have some readily available
information as to what the materials are going to cost them and
have costed out what their time factor is going to cost them.
Then continually having to rebuy either upgrades to it or new
packages periodically all the time because of the ever-changing
mode. What happens is--I mean--the one that they bought if they
have to depreciate over 3 years is useless after less than 1
year, yet they're still expensing it out. It should be just
made a consumable product the same as the way we go and buy
paper--copy paper or----
Chairman Johnson of Connecticut. We do have proposals
before the Ways and Means Committee to reduce the depreciation
time for software. But what you're saying is that it should
just be expensed as a business expense each year.
Mr. Olandt. That's my opinion and most of my clients. Many
of them probably----
Chairman Johnson of Connecticut. What about the expensing
limit? What level do we need to--what level would be useful for
most small businesses so that the Tax Code wouldn't drive the
decision as to whether to buy the equipment this year or a few
months later?
Mr. Olandt. Well, the $18,500 that came into this year--I
mean, it's just not sufficient. You take a person that buys a--
I have a couple of clients that have a lawn mowing business.
They are actually spending for a good high-powered seat big
lawnmower that can cost him anywhere from close to $30,000. So
they're saving that money to put out and then they don't have a
lot of money to cover the taxes on what they can't write off
for that. It would also encourage a lot of other people that
would go into business because they're saving to make this
investment. But they have to be careful because if they spend
everything into their business, they have no money at the end
of the year. They actually get taxed on some of that money
they've already spent. It's extremely hard for the small
business and the person to make a go.
Mr. Steve Bafundo. If I could, on the software issue. One
of the requirements of our appearance before this Subcommittee
is that we came up with software--or our testimony--written in
WordPerfect 5.1. Well, we had a heck of a time finding
WordPerfect 5.1. It's about three or four generations back.
Thank God I have a neighbor that's a packrat that saved his old
version of it. So if you want to see how quickly things are
moving, you only have to look at this Committee itself and take
a look at how quickly software becomes obsolete.
Chairman Johnson of Connecticut. That's very interesting
because we reversed our order this year for this hearing and
had the practitioners come before some of the organized groups.
That really is wonderful--I mean, that's a perfect example of
some--of just a small corner of the difficulties.
Mr. Anthony Bafundo. One other thing they ought to
eliminate is the--they have a lower alternative minimum tax
threshold on the kiddie tax. I have one guy that has nine
children under 14 and takes me about 6 or 7 hours to do those
returns. The----
Chairman Johnson of Connecticut. Just for the kiddie tax
portion?
Mr. Anthony Bafundo. No, there's a $1,000--I think it's
gone up to about 15 now--$1,500.
Chairman Johnson of Connecticut. Yes.
Mr. Anthony Bafundo. It's gone up to $1,500. There's only a
$1,500 limitation on alternative minimum tax for children under
14 years alone--14 years of age. This guy has nine children
under 14 who have income. It takes me 5 or 6 hours to do that
tax return. It's unbelievable. I don't understand why they did
that. I guess they did that because the children are paying at
the parent's rate on the regular tax. But when you get to the
alternative minimum, they end up paying more tax on the
alternative minimum tax than they would on the regular tax
because the low----
Chairman Johnson of Connecticut. You mean the children do?
Mr. Anthony Bafundo. The children, yes.
Chairman Johnson of Connecticut. That's a very good point.
Mr. Anthony Bafundo. Because of the low--it's only a $1,500
exemption as opposed to $45,000 and so forth that you get on
the regular AMT.
Chairman Johnson of Connecticut. What level of expensing
would you recommend given your experience with small
businesses?
Mr. Anthony Bafundo. Well they're taxing the child at the
parent's rate anyway. So I would say--I would raise the limit
to around $5,000--the AMT.
Chairman Johnson of Connecticut. Under the AMT, the limit
for child deductions to $5,000?
Mr. Anthony Bafundo. Yes.
Chairman Johnson of Connecticut. And what about----
Mr. Anthony Bafundo. It's now $1,500.
Chairman Johnson of Connecticut. What about expensing for
small businesses? Would separate startup costs from annual
expensing limits? If so, what would they be? Because we do also
have proposals for a separate start-off--startup cost
deductions. I'm reluctant to get into the complexity of
differentiating between startup costs and----
Mr. Anthony Bafundo. Yes, right.
Chairman Johnson of Connecticut [continuing]. Other year
costs. But, for instance, what is a usable level of expensing?
What would be good to help small businesses grow in terms of
expensing level?
Mr. Anthony Bafundo. Well, I would say that they--I would
say 10,000 to 20,000--somewhere in that area would probably--
for somebody to start up a business. I don't know what you're
considering a startup cost. That's the other question----
Chairman Johnson of Connecticut. But what about on an
annual----
Mr. Anthony Bafundo. You're talking about buying
equipment--equipment, of course, you have the $18,500 anyway.
Chairman Johnson of Connecticut. What about on an annual
basis? What would be a good expensing level to allow?
Mr. Anthony Bafundo. For startup costs?
Chairman Johnson of Connecticut. No, just regular, every
year--annual?
Mr. Anthony Bafundo. From the AMT?
Chairman Johnson of Connecticut. No, just regular tax
expensing level.
Mr. Anthony Bafundo. Oh, you're talking about section 179?
Chairman Johnson of Connecticut. Yes.
Mr. Anthony Bafundo. I'm not quite sure what you're
referring to.
Chairman Johnson of Connecticut. Yes, right, sorry. That's
exactly----
Mr. Anthony Bafundo. Oh, OK. I would say $30,000 would be.
Chairman Johnson of Connecticut. How about the rest of you?
Mr. Evanich. I was going to say my suggestion would be
first--get to the $25,000 or $30,000 as quickly as possible.
Second, that $200,000 limit is really a secondary problem. But
in addition, if a person is involved in more than one business,
not only does each business have that limitation--$18,500 right
now, but the individual also has an overall limitation. So if I
own two businesses, those businesses in aggregate can only have
$18,500 of expenses. So I can't spend $18,500 on each of those
businesses.
Chairman Johnson of Connecticut. So it should be business
specific, not tax specific?
Mr. Anthony Bafundo. For businesses it should be, rather
than limited per individual.
Mr. Olandt. Personally, I'd like to see it go a little
higher, Madam Chairperson, to approximately about $50,000.
Equipment is so expensive today for the small business person.
Again, like I said I have people that have--do lawn care and
their lawnmowers, their tractors that they must use for the big
jobs that they take on are not cheap. They're extremely
expensive. It's not just them. A person that's doing
snowplowing--that buys the truck and the plow and the
attachments to it--$25,000 may sound like a lot but when you
talk--if you're just starting out and you have to put some
office equipment, then office equipment I'm including copy
machines, fax machines, and computer. Also, the regular
equipment to run your business. That $25,000 is eaten up quite
quickly. I'd really like to see for the small business men it
go a little higher.
Chairman Johnson of Connecticut. If there are no further
questions, we'll move onto the other panel. I thank the
witnesses very much for your input. We are going to have a vote
fairly soon, so I want to move on to the other panel. But thank
you very much. As you have other thoughts, please feel free to
share them with us. I thank you for the specificness of your
testimony--that was very helpful.
Robert McIntyre, director of Citizens for Tax Justice;
Michael Mares, American Institute of Certified Public
Accountants; and Robert Weinberger, vice president of H&R
Block. Thank you very much for being with us this afternoon.
We'll start right in so that we can at least get most of the
testimony in before we have to vote.
Mr. McIntyre.
STATEMENT OF ROBERT S. MCINTYRE, DIRECTOR, CITIZENS FOR TAX
JUSTICE
Mr. McIntyre. Thank you, Madam Chairman--or Chairman, or
whatever we say these days. It's great to be after the
Connecticut panel. My wife of 27 years was born in Connecticut,
so it must be a great State--right?
It's also nice to hear you guys talking about tax
simplification. We've been pushing the idea of a fairer and
simpler tax system for years. Of course, given recent history,
it's possible that you'll be striking fear into the hearts of
most taxpayers just bringing up the word simplification, since
it often means something rather different than that when the
rubber hits the road.
If we were having a comprehensive hearing about dealing
with complexity in the Tax Code, I'm sure we would be talking
about the hundreds of billions of dollars of special provisions
in the Code now that are largely responsible for why we have
all this complexity. But I want to focus today--in my brief
time--on one item that didn't sound complex when it was first
proposed, but has become one of the most complicated provisions
in the Tax Code for average taxpayers--and that's last year's
enacted child credit.
You remember when things started, it was just going to be
$500 per kid for everybody. What could be simpler than that?
But then some people said, Well, you know, we really shouldn't
be giving this to high-income people. They don't need the
money. Some other people said Well, we probably shouldn't be
giving this to low-income people because the Congress does need
the money to do other things. Then other people said Well, if
we're going to give this allowance as a tax credit, we want to
make sure it doesn't reduce people's taxes down too low. After
all, that's not a good idea--at least not for people with
significant incomes. So, you ended up with a tax credit
worksheet that I think is going to look a lot like what I've
got up here in this poster.
You are going to spend the first third of the form--like
you do with the dependent care credit now--finding out if these
credits will take you down below what you'd owe under the
alternative minimum tax. To figure that out, you'll have to
compute the alternative minimum tax in many cases.
So we're going to have 27 to 28 million families faced with
the possibility of filling out the minimum tax form just to
determine whether they are allowed to take the new $500 child
credit. Not all of them will have to fill out the whole thing.
Some will be able to stop after awhile, but they'll be facing
one of the most complex forms in the Tax Code for the first
time--thanks to the legislation adopted last year.
Now once you get by the minimum tax--and by the way that
provision actually affects only about half a million out of the
28 million people who will get the child credit, but of those
28 million, many million will have to fill it out----
Chairman Johnson of Connecticut. Excuse me, you mean the
refundable part of it only----
Mr. McIntyre. No, we haven't got to the refundable part
yet--we're doing nonrefundable. We're working our way down this
form to the refundable section. Part 1 deals with the
nonrefundable part of the credit and that's where the
alternative minimum tax comes into play. If the credit turns
out to be refundable, which it is for larger families, then you
don't have to worry as much about the alternative minimum tax,
although there can be interactions where it will become part of
your calculation.
Once you have determined the nonrefundable issues which
involve the alternative minimum tax, then you have to write
down all of your different tax credits separated out between
nonrefundable, personal credits and the other kinds of credits
that are nonrefundable, but aren't called nonrefundable for
purposes of section 26 of the Tax Code and the alternative
minimum tax. That's largely the foreign tax credit, which
involves people who get a dividend from a foreign corporation
or something like that, although there are certain business
credits that fall into this category.
Having listed those credits in separate baskets, you then
go on to start computing. Of course, it depends whether you
have two kids or three which route you will take on the form.
If you have three children or more, you may find the credit is
refundable but you then need to calculate the sum of your
income tax limit in the earlier section plus your FICA taxes
minus the earned income tax credit, and other credits that you
didn't deduct before in computing the other limit. If that
turns out to be bigger than your limit under the first
calculation, which is the nonrefundable limit, that portion may
be refundable to you. Therefore you can get your taxes down in
some cases quite low.
On the other hand, at least as adopted in the 1997 bill,
there's been some technical corrections proposed which have not
yet been adopted which are different, if you would fall into
the nonrefundable situation, but that limit, because of a
foreign tax credit, is greater than your limit as computed
under the refundability portion which normally would not apply
to you as a family with only two children or less, you may find
part of the credit to be refundable. At least that's the
statute that was passed.
So I'm figuring that this probably--and I'll be filling out
this credit form next year--is even more complicated than last
year's new capital gains form. It's also going to be filled out
by a lot more taxpayers.
Most of these complex things were enacted with good
intentions--most of them, not all of them. I think the so-
called supplemental credit was put in for some mean-spirited
reasons. But most of it was done for ostensibly good reasons.
Yet all this complexity turns out not to amount to much except
as complexity, and probably could be dispensed with to a large
degree--if you treated simplification as an important item on
the agenda. I hope you do. I hope that as you move forward to
deal with other tax legislation, that you also hire somebody on
the Joint Tax Committee as the Tax Simplification Monitor and
find out what these tax forms are going to look like before you
pass another piece of legislation that turns out to be as
monstrous as this one has turned out to be. Thank you.
[The prepared statement follows. The attachments are being
retained in the Committee files.]
Statement of Robert S. McIntyre, Director, Citizens for Tax Justice
Today's topic before the Subcommittee is tax complexity. A
comprehensive discussion of this issue would, by necessity,
address the hundreds of billions of dollars worth of provisions
that have been put into the tax code for reasons extraneous to
fair and efficient tax collection--generally to encourage
behavioral changes or simply to reward certain activities or
taxpayers. As long-time advocates of a simpler, fairer tax
system, we at Citizens for Tax Justice have written and
testified extensively on this topic. See, for example, The
Hidden Entitlements (1996), available from our office or at our
web site, www.ctj.org.
Today, however, I want to limit my remarks to a discussion
of the rather extraordinary complexity introduced by one,
seemingly innocuous new tax provision: the $500 per child tax
credit adopted in the 1997 Taxpayer Relief Act.
The $500 Child Credit: A Case Study in Complexity
The new child tax credit provision of the tax law had its
genesis in the notion that every family in America should get a
$500 allowance for each of their children. But other
considerations quickly emerged.
Some people didn't think that such an allowance made much
sense for well-off families. Others argued that it shouldn't go
to lower-income families either (in part based on cost
considerations). And because the $500 allowance was conceived
from the beginning as a tax credit--apparently so it could be
described as a (praiseworthy) tax cut rather than a (wicked)
spending increase--many worried about excusing large families
with significant incomes from paying any income tax at all.
As a result of all these conflicting goals, we now have a
child tax credit that will require potentially qualifying
taxpayers to fill out not only a new child-credit tax form, but
also an extremely complicated new worksheet and in some cases
the Alternative Minimum Tax form--a combination often even more
complex than the much-bemoaned new capital gains tax
calculation form also mandated by the 1997 tax act.
The new child credit form itself will probably not be
hugely complex, and I will not dwell on it here. Essentially,
the new form will require taxpayers to list and count their
children age 16 and under, multiply that amount by $500 ($400
for tax year 1998) and, if necessary, apply the income phase-
out rules at higher income levels.
The real complexity of the new child credit arises when it
comes to the ``worksheet'' that must be completed to calculate
various other limits on the credit and to determine whether it
is refundable or non-refundable. In broad strokes, this
worksheet is designed (1) so that the credit cannot reduce tax
liability below what would be owed under the Alternative
Minimum Tax for families with one or two children, and (2) for
larger families, so the credit cannot exceed combined income
and FICA tax liability less the earned-income tax credit.
I have devised an example of a new child credit limit
worksheet, based on the statutory goals it must accomplish. The
new worksheet can be combined with the old 10-line credit-limit
worksheet for the dependent care credit, with the addition of
18 new lines. I've attached a representation of such a new
worksheet, along with several examples of filled-income
worksheets by taxpayers in different situations.
Here is a brief line-by-line explanation of what taxpayers
will face in completing the new child credit (and dependent
care credit) limit worksheet:
Lines 1-11 of the new worksheet are based on the design of
the current dependent care credit limit worksheet. The purpose
is to limit certain non-refundable tax credits, mainly the
dependent care credit and the new child credit, so that they do
not reduce tax liability below what would be owed under the
Alternative Minimum Tax (AMT). To calculate their credit
limits, taxpayers claiming the dependent care credit and/or the
$500 child credit must fill out either the complex AMT form (a
copy is attached) or in some cases a shortened version of the
AMT computation provided on the credit limit worksheet itself.
Because of its fairly large exemption--$45,000 for couples
and $33,750 for unmarrieds--the AMT doesn't actually affect
many child credit claimants (even if they do have to fill out
the form). But some middle-income couples with lots of children
may find that the AMT can limit the amount of dependent care
credit and child credit they're allowed to take--although
generally only because their taxes are very, very low. The
effects of this rule on the $500 child credit, however, are
substantially mitigated by the refundable rule for families
with more than two children. See example 7.
Lines 12-14 of the new worksheet list other non-refundable
credits that come into play in calculating the limits on the
$500 child credit. It should be noted that the foreign tax
credit and certain business credits are treated differently
than other non-refundable credits in calculating the limit on
the $500 child credit for families with one or two children. In
effect, some families who have these kinds of credits may be
eligible for a partially or fully refundable child credit,
while families with similar amounts of other types of non-
refundable credits would not be eligible for a refundable child
credit. See example 6. One rationale for special treatment of
the foreign tax credit may be the principle that we do not
intend to tax foreign income twice.\1\
---------------------------------------------------------------------------
\1\ Different technical corrections included in the pending House
and Senate IRS restructuring bills rewrite this refundability rule, and
appear to make it inoperative for families with fewer than three
children and largely meaningless, albeit still quite complicated, for
larger families.
---------------------------------------------------------------------------
Oddly, for families with 3 or more children, it is
sometimes advisable not to claim an otherwise claimable foreign
tax credit or business credit, because these credits do affect
refundability of the $500 child credit under the alternative
limit calculation (limit B). Not many taxpayers take the
foreign tax credit, but for those who do, making this
determination will probably require professional assistance.
See example 4.
Lines 15-20 compute the $500 child credit under limit B,
which can generate a refundable credit. For families with three
or more children, the portion of the credit that is refundable
is equal to the excess of the sum of the regular non-refundable
credit limit and FICA taxes, less the earned-income tax credit,
over credit limit A (see below). Although generally, these
calculations are applicable only to families with three or more
children, they can also be necessary for taxpayers with one or
two children who also have foreign tax credits or certain
business credits.\2\
---------------------------------------------------------------------------
\2\ See footnote 1.
---------------------------------------------------------------------------
Line 21 calculates the $500 child credit under limit A.
Under this limit, the child credit cannot reduce taxes (after
other non-refundable credits, such as the dependent care
credit) below what would be owed under the Alternative Minimum
Tax. The credit computed under limit A is generally a non-
refundable credit, but if the limit calculated here is bigger
than the amount computed under limit B, then the excess will be
refundable. Generally, this only affects taxpayers with foreign
tax credits. See example 6.\3\
---------------------------------------------------------------------------
\3\ See footnote 1.
---------------------------------------------------------------------------
Lines 22-26 get to the final child tax credit, parsing it
between non-refundable and refundable portions. This
distinction does not always matter, but often will, especially
for families with large numbers of children.
Lessons from the Complexity of the Child Credit
So there we have it. An apparently simple idea--to give
every family $500 for each child--has been transformed into one
of the more complicated items in the tax code from the point of
view of affected tax filers.
What can we learn from this? For one thing, it illustrates
the danger, even folly, of trying to implement non-tax policies
through the tax code. Our instinctive insistence that tax laws
be fair makes it difficult to use the tax code for non-tax
policy purposes without adding much more complexity than a
direct spending program would typically entail. Similar
criticisms, of course, can be leveled at many other tax-based
spending programs, including many adopted in last year's tax
act.
Of course, even a tax code that is limited as much as
possible to the goal of collecting enough revenue to pay for
government programs fairly and efficiently will have some
complexity. Business taxation, in particular, will always be
complicated, both because of the inherent complexity of
business itself and because overly simple rules can often be
gamed by aggressive taxpayers. Tax proposals that pretend
otherwise, such as the flat tax, are frauds.
But we can and should make our tax laws much simpler than
they are today for the vast majority of taxpayers. Indeed, the
tax code after the Tax Reform Act of 1986 was far simpler for
most people than it had been. It is only in recent years that a
bipartisan coalition of tax complexifiers has moved us so far
away from the principle of tax simplicity.
Tax simplification, does not, by the way, require
compromising progressivity. On the contrary, those who promote
radical tax redistribution proposals like the flat tax or a
national sales tax get in the way of true simplification. It's
not just that these half-baked proposals are actually far more
complex than advertised. More important, middle-and low-income
voters are not likely to tolerate paying a much larger share of
the tax burden than they do now in the name of simplicity (as
the single rate plans would necessarily require). The recent,
widely criticized House vote to abolish the tax code without
naming a replacement illustrates the widespread understanding
by members of Congress of the politically disastrous nature of
these flat-rate proposals.
Although recent history makes one wary, the right kind of
comprehensive, progressive tax reform remains an excellent
idea. Proposals like Representative Gephardt's plan show that
it is at least theoretically possible. In the meantime, members
of the tax-writing committees ought to focus more on using the
tax code for its primary purpose of raising revenue fairly,
rather than as a tool of economic and social policy. Or if
that's a pipe dream in the short run, then what Congress
wrought in enacting last year's child credit should at least
encourage taxwriters to pay a lot more attention to complexity
issues when they pass tax laws.
Chairman Johnson of Connecticut. Thank you, Mr. McIntyre.
Just for the record, you probably are aware that in the IRS
reform bill, we do include in the Conference Committee, as we
write tax legislation a member of the IRS--a tax expert from
the IRS--so that we can try to avoid this kind of problem in
the future to a far greater extent than we have in the past.
There's a famous story about 2 lines of pension law that result
in 1,000 pages of regulations. So I am very interested to--I
was not aware that the child credit had resulted in such
extraordinary complexity. In the testimony of the earlier
panel, it's very clear that reverberations on this are families
through the alternative minimum tax mechanism. I'd like to
recognize Michael Mares from the American Institute of
Certified Public Accountants.
STATEMENT OF MICHAEL MARES, CHAIR, TAX EXECUTIVE COMMITTEE,
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Mr. Mares. Thank you and good afternoon, Madam Chair and
Members of this distinguished Subcommittee.
The AICPA has long been an advocate of tax simplification.
Tax law complexity helps create perceptions of unfairness,
difficulty of administering the laws, it increases compliance
cost, and it interferes with economic transaction decisions.
The end result of this is an erosion of voluntary compliance.
To maintain a voluntary tax system that's viable,
simplification must have a prominent position in the tax
process. Although it should not necessarily take precedence
over revenue and tax policy objectives. While a tax system that
is simple for all taxpayers may never be designed,
simplification must be an integral part of the system both from
the legislative and regulatory process, as well as from the
administrative process.
We believe at least four elements are necessary to create a
simpler tax system--both through new legislative proposals and
a review of existing law. First, there must be a visible
constituency. That constituency must communicate the need for
simplification to Congress and to the administration. Next,
guiding principles for tax simplification must be identified
followed by factors that contribute to complexity must also be
identified. Finally, simplification must be considered at all
stages of the process. I will spend the rest of my time
discussing specific areas of complexity, particularly the
alternative minimum tax, or AMT.
The AMT is one of the most complex parts of our tax system.
Among its numerous complexities is the maintenance of a number
of supplementary schedules for many years to allow the
computation of future AMT items as the adjustments and
preferences turn around. This complexity also calls into
serious question the ability of the IRS to audit compliance
with the AMT. Unfortunately several items enacted in the
Taxpayer Relief Act of 1997 will have a dramatic impact on the
number of individuals who will find themselves shifting to the
alternative tax system. Many of these have been previously
discussed in prior testimony. For many this will be a shock and
in all likelihood will cause further problems for the IRS,
which will have to dedicate significant resources to ensure
compliance, educate taxpayers, and handle taxpayers' questions.
We wish we had the answer to the problem, but we recognize
there is no simple solution given the likely revenue loss to
the government. As a start, however, Congress should consider
first, indexing the AMT brackets and exemption amounts. Then
allowing some or all of an individual's itemized deductions and
personal exemptions as adjustments to regular taxable income in
arriving at AMT. Third, Congress could eliminate many of the
AMT preferences by reducing for all taxpayers the regular tax
benefits of some AMT preferences. For example, extending
regular depreciable lives.
Next Congress should consider allowing certain regular tax
credit against AMT such as the child credit, or the education
credit as had been mentioned earlier. Providing an exemption
for AMT for low- and middle-income tax payers with regular,
taxable adjusted gross income of less than $100,000 would go a
long way toward alleviating many of the problems discussed.
Finally, and perhaps most importantly, Congress should consider
the impact of alternative minimum tax on all future tax
legislation.
Due to the increasing complexity, compliance problems and a
perceived lack of fairness toward the intended target, an
additional alternative Congress might also want to consider is
repealing the individual AMT altogether. Hidden tax breaks are
another result of the complexity added to our tax laws over the
past decade. The phaseouts of itemized deductions, personal
exemptions, IRA deductions are examples of provisions which
increase the effective tax rate individuals pay. Since married
filing separate taxpayers are denied many deductions outright,
their effective tax rate is even higher. Instead of a
straightforward tax rate increase, Congress has used back-door
approaches such as phaseouts and limitations to raise the
effective tax rate on high-income individuals.
Under section 179, taxpayers may elect to treat the cost of
certain qualified property as an expense rather than a capital
asset. For each dollar of section 179 expense--in excess of the
$200,000 cap--the maximum amount of deduction will be reduced
by each dollar. Since the maximum deductible amount is being
increased from $17,525, we believe the $200,000 cap should also
be raised incrementally to be consistent. It also is equitable.
It would also assist small businesses to take advantage of this
particular election.
In today's world, one piece of machinery or even several
pieces of machinery can easily exceed this limit. We would be
happy to work with you on any specific proposals as this
Congress moves forward in this complex area that deserves
careful analysis and consideration. We thank you for this
opportunity to present our comments and suggestions on
simplifying the tax law. I will be happy to answer any
questions you may have.
[The prepared statement and attachment follow. Additional
attachments are being retained in the Committee files.]
Statement of Michael Mares, Chair, Tax Executive Committee, American
Institute of Certified Public Accountants
Introduction
Good morning, Madam Chair, and members of this
distinguished Subcommittee. We appreciate this opportunity to
testify today on simplification, individual alternative minimum
tax (AMT), tax rates and phase-outs. I am Michael Mares, Chair
of the Tax Executive Committee of the American Institute of
Certified Public Accountants (AICPA). The AICPA is the national
professional organization of CPAs, with more than 331,000
members. Many of our members are tax practitioners who,
collectively, prepare income tax returns for millions of
Americans.
Simplification
The AICPA has long been an advocate of simplification of
the tax system. The complexity of our tax law has reached the
point where many taxpayers and practitioners believe that it is
undermining voluntary compliance. Frequent change, the lack of
deliberation in the legislative process, and the increasing
magnitude and complexity of the Internal Revenue Code are our
principal concerns. The following significant problems result
from existing tax complexity:
Perceptions of unfairness. The lax law is
perceived by many as unfair.
Difficulty of administration. It is difficult for
the Internal Revenue Service to administer the tax law.
Compliance costs. The cost of compliance for all
taxpayers is increased. Of particular concern are the many
taxpayers, especially those with unsophisticated financial
affairs who are forced to seek professional tax return-
preparation assistance.
Interference with economic transactions.
Complexity interferes with economic decision making.
The end result is erosion of voluntary compliance.
Taxpayers and tax practitioners simply find it harder to
understand and comply with the tax law.
To maintain a viable voluntary tax system, simplification
must have a prominent position in the tax process, although it
should not take precedence over revenue and tax policy
objectives. While a tax system that is simple for all taxpayers
may never be designed, simplification must be an integral part
of the tax legislative, regulatory, and administrative process.
What is Needed
At least four elements are necessary to create a simpler
tax system, both through new legislative proposals and a review
of existing tax law:
A visible constituency must communicate the need
for simplification to Congress and the Administration.
Guiding principles for tax simplification must be
identified.
Factors that contribute to complexity must be
identified. This will lead to development of a framework for
analyzing the balance among equity, policy, revenue, and
simplification objectives.
Simplification must be considered at all stages of
the legislative process. The process itself must provide
thorough consideration of tax proposals, including
simplification issues.
Guiding Principles and Factors that Result in Complexity
We believe the guiding principles in pursing a simpler tax
law are:
The legislative process should consider the
objectives of equity, efficiency and revenue needs, balancing
them with simplification.
Once tax policy objectives have been identified,
alternative approaches to implementing the policy should be
considered to provide the simplest possible design and
administration.
The long-term benefit of any change made to
simplify the tax law should more than offset any transitory
complexity that results by a change.
The law and regulations should be drafted within a
rational, consistent framework.
There should be a balance between simple general
rules and more complex detailed rules.
The benefit of a provision should be weighed
against the cost of compliance.
Tax rules should build on common industry record
keeping and business practices.
We also must recognize that the following factors create
complexity:
The effects of change;
Subjectivity;
Lack of consistent concepts;
Structural complexity;
The effect on taxpayers not targeted by a
particular provision;
Forms;
Administrative issues;
Transactional application and business dynamics;
Diffusion of responsibility;
Inconsistent application of rules; and
The legislative process.
One approach to evaluating these factors is the use of the
attached complexity index. Assistance in evaluating a
proposal's contribution to simplification or complexity is
needed. There must be a framework for considering tax
legislative proposals. It is not sufficient to merely develop
tools for measuring a proposal's effect on the complexity of
the law. Procedures should be adopted to ensure that the tools
are used and that the information obtained is formally
considered in the process.
The AICPA has drafted and proposed many simplification
proposals targeting specific areas of the tax law, including
AMT, phase-outs, and rates, which are covered in our testimony.
In addition, we have drafted individual tax simplification
proposals for: the earned income tax credit, capital gains tax,
estimated tax safe harbor, kiddie tax, education IRAs,
underpayments, charitable contributions, mileage allowance,
domestic relations, and interest expense; as well as various
small business tax simplification proposals for: section 179
expensing, self-employed health insurance premium deduction,
employee versus independent contractor, and the half-year
requirements. We have included these proposals at the end of
our testimony. Please feel free to review the attached
proposals for further details on these issues.
Background on AMT
Our tax laws give special treatment to certain types of
income and allow special deductions for certain expenses. These
laws enable some taxpayers with substantial economic income to
significantly reduce or eliminate their regular tax. The
purpose of the AMT is to ensure that these taxpayers pay a
minimum amount of tax on their economic income.
Complexity of AMT
The AMT is one of the most complex parts of the tax system.
Each of the adjustments of Internal Revenue Code (IRC) section
56, and preferences of IRC section 57, requires computation of
the income or expense item under the separate AMT system. The
supplementary schedules used to compute many of the necessary
adjustments and preferences must be maintained for many years
to allow the computation of future AMT as items ``turn
around.''
Generally, the fact that AMT cannot always be calculated
directly from information on the tax return makes the
computation extremely difficult for taxpayers preparing their
own returns. This complexity also calls into question the
ability of the Internal Revenue Service (IRS) to audit
compliance with the AMT. The inclusion of adjustments and
preferences from ``pass through'' entities also contributes to
the complexity of the AMT system.
Effects of the Taxpayer Relief Act of 1997 and AMT on Individual
Taxpayers
Several items enacted in the Taxpayer Relief Act of 1997
will have a dramatic impact on the number of individuals who
will find themselves shifting to the alternative minimum tax
(AMT) system in addition to being subject to tax under the
regular tax system. For many, this will come as a real surprise
and, in all likelihood, will cause substantial problems for the
IRS, which will have to redirect significant resources to this
area in the future to ensure compliance, educate taxpayers, and
handle taxpayer questions.
In fact, John Scholz, Deputy Assistant Secretary in the
Treasury Tax Policy Analysis Office, has stated that the number
of taxpayers subject to the AMT (which is currently less than
one percent) is expected to escalate 30 percent a year for at
least ten years. He noted that the trend will mean eight
percent of United States taxpayers, or 11 million individuals,
will be subject to AMT by 2007. One point to keep in mind--11
million individuals will actually have to pay the AMT, how many
million more will have to fill out the complex Form 6251 to
show they do not owe it?
Most sophisticated taxpayers understand that there is an
alternative tax system, and that they may sometimes wind up in
its clutches; unsophisticated taxpayers may never have even
heard of the AMT, certainly do not understand it, and do not
expect to ever have to worry about it. Unfortunately, that is
changing--and fairly rapidly--since a number of the more
popular items, such as the education and child credits that
were recently enacted, offset only regular tax and not AMT. Due
to these changes, we believe it is most important that Congress
obtain information (from Treasury, the Joint Committee on
Taxation staff, or OMB) not only as to the revenue impact of
the interaction of all these recent tax changes with the AMT,
but also of the likely number of families or individuals that
will be paying AMT as a result of 1997's tax legislation.
Specifically, taxpayers' situations will be exacerbated by
the following.
1. The child tax credit is not available against the AMT.
Thus, middle-income taxpayers will see their regular tax go
down by $500 or more (depending upon the number of dependent
children), but their AMT potential liability will not be
reduced at all.
2. Under the Hope tuition tax credit, middle-income
families receive up to a $1,500 credit, per eligible student,
for regular tax purposes, though none of the credit is
available against AMT. The same is true of the Lifetime
Learning Credit, with a maximum $1,000 credit through 2002, and
$2,000 credit thereafter. These credits alone will generate a
substantial number of new AMT filers. With one or more children
in college and others at home under 17 years of age, the result
is a large group of taxpayers who would, under no
circumstances, be considered rich, but who will now be paying
the alternative minimum tax.
For example, a couple with a teenage child ($400 child care
credit), a child in the first year of college ($1,500 Hope
Scholarship Credit), and a child in the last year of college
($1,000 Lifetime Learning Credit), with total earnings of
$65,000; $3,000 of interest and dividends; $500 each IRA
deductions; a standard deduction of $7,100 and $13,500 of
personal exemptions would have a net regular tax liability of
$4,587 ($7,487 tax, less $2,900 credits), but because of AMT
would lose the benefit of $1,133 of those credits. (See the
attached Appendix E for further details.)
Another example (also in Appendix E) is a head of household
taxpayer, earning $45,000; with $500 interest and dividends; a
$750 IRA deduction; $6,250 of standard deduction, and $8,100 of
personal exemptions for herself, one child with a $1,500 Hope
Scholarship Credit and one child with a $1,000 Lifetime
Learning Credit. This taxpayer loses $800 of credits due to the
AMT.
Indexing the AMT Brackets and Exemption
While the AICPA has not undertaken detailed studies,
anecdotal examples (such as those in our attached Appendix E)
indicate the likelihood that taxpayers with adjusted gross
incomes in the $60,000-$70,000 range (or below) will be subject
to AMT. Aside from the fairness issues involved--this is not
the group that the AMT has ever been targeted to hit--we see
some potentially serious problems of compliance and
administration. Many of these taxpayers have no idea that they
may be subject to the AMT (if, indeed, they are even aware that
there is an AMT). Thus, we anticipate large numbers of
taxpayers not filling out a Form 6251 or paying the AMT who may
be required to do so, thus requiring extra enforcement efforts
on the part of the IRS to make these individuals (most of whom
will be filing in absolute good faith) aware of their added tax
obligations. Further, IRS notices to these taxpayers assessing
the proper AMT may well be perceived as unfair, subjecting the
IRS to unfair criticism that should be directed elsewhere.
Individual AMT Recommendations
We wish we had ``the'' answer to the problem, but recognize
there is no simple solution given the likely revenue loss to
the government. As a start, however, Congress should consider:
Indexing the AMT brackets and exemption amounts.
Eliminating itemized deductions and personal
exemptions as adjustments to regular taxable income in arriving
at alternative minimum taxable income (AMTI) (e.g., all--or
possibly a percentage of--itemized deductions would be
deductible for AMTI purposes).
Eliminating many of the AMT preferences by
reducing for all taxpayers the regular tax benefits of AMT
preferences (e.g., require longer lives for regular tax
depreciation).
Allowing certain regular tax credits against AMT
(e.g., low-income tax credit, tuition tax credits).
Providing an exemption from AMT for low and
middle-income taxpayers with regular tax AGI of less than
$100,000.
Considering AMT impact in all future tax
legislation.
Due to the increasing complexity, compliance problems, and
a perceived lack of fairness towards the intended target, an
additional alternative Congress might also want to consider is
eliminating the individual AMT altogether.
Contribution to Simplification of AMT
The goal of fairness that is the basis for AMT has created
hardship and complexity for many taxpayers who have not used
preferences to lower their taxes but have been caught up in
AMT's attempt to bring fairness. Many of these individuals are
not aware of these rules and complete their return themselves,
causing confusion and errors. The 1997 law and the impact of
inflation on indexed tax brackets and the AMT exemption are
causing more lower income taxpayers to be inadvertently subject
to AMT. Recommendation 1 of indexing the AMT brackets and
exemption would solve this problem.
Under recommendation 2, those individuals who are affected
only by itemized deductions and personal exemption adjustments
would no longer have to compute the AMT. Itemized deductions
are already reduced by the 3 percent AGI adjustment, 2 percent
AGI miscellaneous itemized deduction disallowance, 7.5 percent
AGI medical expense disallowance, $100 and 10 percent AGI
casualty loss disallowance, and the 50 percent disallowance for
meals and entertainment. Similarly, the phase out of exemptions
already affects high income taxpayers. It is also worth noting
that because state income taxes vary, taxpayers in high income
tax states may incur AMT solely based on the state in which
they live, while other taxpayers with the same adjusted gross
income (AGI), but who live in states with lower or no state
income taxes, would not pay AMT.
In addition, under recommendation 3, many of the AMT
preferences could be eliminated by reducing for all taxpayers
the regular tax benefits of present law AMT preferences (e.g.,
require longer lives for regular tax depreciation). This would
add substantial simplification to the Code, recordkeeping and
tax returns. Under recommendation 4, those who are allowed
regular tax credits, such as the low income or tuition tax
credits, would be allowed to decrease their AMT liability by
the credits. This would increase simplicity and create
fairness. Compliance would be improved.
Under recommendation 5, fewer taxpayers will be subject to
AMT and the associated problems. By increasing the AMT
exemption to exclude low and middle income taxpayers, the AMT
will again be aimed at its original target--the high-income
taxpayer.
By eliminating AMT altogether, all the individual AMT
problems would be solved.
Conclusion on AMT
In conclusion, we see AMT as becoming more prevalent and
causing considerable disillusion to many taxpayers who do not
see themselves as wealthy and who will believe they are being
``punished'' unfairly. AMT will apply to many taxpayers it was
not originally intended to affect. We believe our proposals
offer a wide range of ways to help reduce this problem.
Hidden tax rates
Hidden tax rates are a result of the complexity added to
our tax laws over the last decade. The phase-outs of itemized
deductions, personal exemptions, and IRA deductions are
examples of hidden rates which add to the effective tax rate
individuals pay. In addition, the limitation on deductions,
such as 7.5 percent of AGI for medical expenses, 2 percent of
AGI for miscellaneous itemized deductions, and 10 percent of
AGI for casualty losses increases the effective tax rate for
many individuals. Since married filing separate taxpayers are
denied many deductions, their effective tax rate is even
higher. There has been a reluctance by Congress to raise tax
rates to achieve progressivity. Instead of a straight forward
rate increase, Congress has used backdoor approaches, such as,
phase-outs and limitations to raise the effective tax rate on
high-income individuals. A chart detailing many of the phase-
outs in current law is attached.
For example, under current law, if an individual's adjusted
gross income exceeds a certain level, otherwise allowable
itemized deductions are reduced. Likewise, the personal
exemption amount for a taxpayer whose adjusted gross income
exceeds a specified threshold is reduced. The goal of these
measures is to increase the progressivity of the tax system by
having high income taxpayers pay a greater tax burden. However,
the same results could be achieved through adjusting the top
tax rate. It is our understanding that H.R. 4053, recently
introduced by Representatives Rangel and Neal, would simplify
and repeal the phase-outs on itemized deductions and personal
exemptions, and would replace them with a straight forward rate
increase. We support such an approach.
The impact of new or complex tax laws and complicated
phase-outs must be considered when tax legislation is enacted.
Congress should actively strive for simplification and
stability. Tax law complexity originates with the statutes.
Higher than advertised effective tax rates result from limiting
provisions throughout the Code to certain taxpayers, instead of
simply increasing tax rates. Tax law complexity is the result.
The phase-outs are the clearest example of hidden tax rates, so
we have concentrated the remainder of our testimony on them.
Background on Phase-outs Based on Income Level
Numerous sections in the tax law provide for the phase-out
of benefits from certain deductions or credits over various
ranges of income based on various measures of the taxpayer's
income. There is currently no consistency among these phase-
outs in either the measure of income, the range of income over
which the phase-outs apply, or the method of applying the
phase-outs. Furthermore, the ranges for a particular phase-out
often differ depending on filing status, but even these
differences are not consistent. For example, the traditional
IRA deduction phases out over a different range of income for
single filers than it does for married-joint filers; whereas
the $25,000 allowance for passive losses from rental activities
for active participants phases out over the same range of
income for both single and married-joint filers. Consequently,
these phase-outs cause inordinate complexity, particularly for
taxpayers attempting to prepare their tax returns manually; and
the instructions for applying the phase-outs are of relatively
little help. See the attached Appendices A and B for a listing
of most current phase-outs, including their respective income
measurements, phase-out ranges (for 1998) and phase-out
methods.
Currently, many of the phase-out ranges for married-filing-
separate (MFS) taxpayers are 50 percent of the range for
married-filing-joint (MFJ), while many of the phase-out ranges
for single and head of household (HOH) taxpayers are 75 percent
of married-joint. That increases the marriage penalty as the
spouses' incomes become equal.
Recommended Change to the Phase-outs
Simplicity can be achieved by eliminating phase-outs
altogether. However, if that is considered either inequitable
(simplicity is often at odds with equity) or bad tax policy,
significant simplification can be achieved by providing
consistency in the measure of income, the range of phase-out
(including as between filing statuses) and the method of phase-
out.
Instead of the 20 or so different phase-out ranges (shown
in attached Appendix C), there should only be three phase-out
ranges for low, middle, and high income taxpayers.
If there are revenue concerns, the ranges and percentages
could be adjusted, so long as the phase-outs for each income
level group (i.e., low, middle, high income) remained
consistent for all relevant provisions. In addition, the
``marriage penalty'' impact should be considered in adjusting
phase-out ranges for revenue needs.
We have proposed that, to eliminate the marriage penalty
and simplify the Code, all phase-out ranges for married-filing-
separate (MFS) taxpayers would be the same as those for single
and head of household (HOH) taxpayers, which would be 50
percent of the range for married-filing-joint (MFJ) range.
The benefits that are specifically targeted to low-income
taxpayers, such as the earned income credit, elderly credit,
and dependent care credit, would phase-out under the low-income
taxpayer phase-out range. The benefits that are targeted not to
exceed middle income levels, such as the traditional IRA
deduction and education loan interest expense deduction, would
phase-out under the middle-income taxpayer phase-out range.
Likewise, those benefits that are targeted not to exceed high
income levels, such as the new child credit, new education
credits and IRA, and the new Roth IRA, as well as the existing
law AMT exemption, itemized deductions, personal exemptions,
adoption credit and exclusion, series EE bond exclusion, and
section 469 $25,000 rental exclusion and credit, would phase-
out under the high-income taxpayer phase-out range. See the
chart below.
Additionally, instead of the differing methods of phase-
outs (shown in attached Appendix D), the phase-out methodology
for all phase-outs would be the same, such that the benefit
phases out evenly over the phase-out range. Every phase-out
should be based on adjusted gross income (AGI).
Proposed Income Level Range for Beginning to End of Phase-Out for Each
Filing Status
------------------------------------------------------------------------
Married
Category of Taxpayer Filing Single &
Joint HOH & MFS
------------------------------------------------------------------------
LOW-INCOME.................................... $15,000-$37
,500 $7,500-$18,
750
MIDDLE-INCOME................................. $60,000-$75
,000 $30,000-$37
,500
HIGH-INCOME................................... $225,000-$4
50,000 $112,500-$2
25,000
------------------------------------------------------------------------
Contribution to Simplification of Phase-outs
The current law phase-outs complicate tax returns immensely
and impose marriage penalties. The instructions are difficult
to understand and the computations often are difficult to do
manually. The differences among the various phase-out income
levels are significant. True simplicity could easily be
accomplished by eliminating phase-outs altogether. However, if
that is not feasible, for whatever reason, significant
simplification can be achieved by creating consistency in the
measure of income, the phase-out range (including as between
filing statuses) and the phase-out methodology. The phase-outs
should be eliminated by adjusting rates, or by applying the
phase-outs to consistent ranges, using a consistent
methodology. This would ease the compliance burden on many
individuals. If there were only three ranges to remember and
only one methodology, it would be a lot simpler and easier to
recognize when and how a phase-out applies. Many portions of
numerous Internal Revenue Code sections could be eliminated. By
making the MFJ phaseout ranges double the ranges applicable to
single individuals and making the MFS ranges the same as single
individuals, the marriage penalty attributable to phase-out
ranges would be eliminated.
Expensing Deduction
Under section 179, taxpayers may elect to treat the cost of
qualifying property as an expense rather than a capital asset.
Section 179 will be gradually increased to $25,000 by year
2003. This section restricts the amount of the election in
circumstances where the taxpayer places into service qualifying
property in excess of $200,000. For each dollar of section 179
property in excess of $200,000, the maximum credit ($18,000 for
1997) will be reduced by one dollar. We suggest the maximum
deductible amount is being increased from $17,500 to $25,000.
The $200,000 limit should also be raised in increments to stay
even. It would be equitable. Plus, it assists small businesses
to be able to take advantage of this election. In today's
world, one piece of machinery or several pieces of equipment
can easily exceed this limit.
Conclusion
We would be happy to work with you on specific proposals as
this Congress moves forward in this complex area that deserves
careful analysis and consideration. The AICPA again thanks you
for this opportunity to present our comments and suggestions on
simplifying AMT, tax rates and phase-outs.
Chairman Johnson of Connecticut. Thank you very much. You
should know that actually the accountants, 2 years ago,
developed some simplification proposals and brought them around
to their members. That really is the ground of which this
hearing grew. I appreciate your input very much, and
particularly the detail in your testimony.
Mr. Weinberger.
STATEMENT OF ROBERT A. WEINBERGER, VICE PRESIDENT, GOVERNMENT
RELATIONS, H&R BLOCK; ACCOMPANIED BY ANITA EDWARDS, TAX
PREPARER, H&R BLOCK
Mr. Weinberger. Thank you, Madam Chair, and Members of the
Subcommittee. I'm Bob Weinberger, vice president for government
relations at H&R Block. I'm part of the team that prepared the
10 simplification suggestions we submitted in 1997 and 1998.
With me this afternoon is Anita Edwards, from Olney, Maryland,
who's been an H&R Block tax preparer for the past 22 years and
who can join me in responding to your questions.
Just a brief word about H&R Block. We're the Nation's
largest tax preparation company. At our 8,800 offices
throughout the country, we handle 15.6 million individual
returns--which is about 1 out of every 7 received by the IRS.
That works out to about 36,000 per congressional district. We
also do over half the electronic returns that practitioners
filed with the IRS and produce tax software in the form of
Kiplinger's TaxCut.
I have four points that I want to stress today before
addressing particular changes.
The first is that simplicity is often offset by other
important objectives for a tax system such as fairness,
enforceability, economic efficiency and incentives for saving
and economic growth.
One brief example is the adoption credit. It is thought
widely to be good public policy but it adds complexity to the
Code. It trades off simplicity for a valuable social policy
goal.
Second, preparing tax returns is relatively simple for most
Americans, although recent laws are making returns more
complex. Complexity is concentrated on high-income and business
taxpayers. This is a point which I think is important to make
to give the discussion about complex provisions some context.
Millions of Americans are below the filing threshold. Of
the 124 million who do file, about 52 million or 42 percent
either file a 1040-EZ or a 1040-A form, both of which are
relatively simple. Twenty-six million of them are able to file
by a telephone through the IRS TeleFile Program. Over 70
percent of taxpayers take the standard deduction and do not
itemize. For these taxpayers, the tax system is still
relatively simple.
The burden of complexity focuses on business filers,
especially on small businesses, on those who are self-employed,
and on high-income individuals who itemize and have income from
passive activities or in the form of capital gains, dividends,
rents, and pension and annuity disbursements.
While over one-half of taxpayers do use a tax preparer, and
complexity is certainly one reason, many taxpayers do so
primarily to expedite their refund, which 70 percent receive,
or to free more time for family or other pursuits. Many of us
are capable of changing the oil in our car but find that paying
someone to do it allows better use of our time.
That picture may be changing. The Taxpayer Relief Act of
1997 is a major culprit with complex capital gains and IRA
changes and new credits with multiple phaseouts, although it
does simplify taxes on home sales.
Similarly, the alternative minimum tax, forms now filled
out by fewer than 1 percent of taxpayers, will be required of 6
to 8 percent in a decade. Many taxpayers who don't consider
themselves wealthy but use credits for education, children or
dependent care may be surprised to find themselves subject to
the AMT.
But while these provisions are genuinely complex, they
still affect a minority of taxpayers, albeit an increasingly
significant and understandably vocal minority.
Third, the main reasons for complexity have little to do
with progressive tax brackets. But they arise from defining
income, rewarding congressionally favored activities, and
meeting budget needs. A multirate structure may invite
complicated tax minimization strategies and activities, but it
is not a cause of complexity by itself. Most taxpayers simply
look up their tax in a table or apply a formula.
There are other reasons for complexity which are in the
province of the Committee. They involve tailoring or
personalizing the tax system to individual circumstances. For
example, the earned income tax credit would be less complex if
it were less finely tuned to family circumstances. The simplest
of taxes, a poll tax, which is one-size-fits-all is very
unfair. So complexity may be a byproduct of achieving other
goals like personalization that achieves fairness.
Also, Congress and the administration, for example, have
increasingly turned to targeted tax cuts, credits and
deductions as more attractive vehicles for programs than
traditional spending through government agencies--which again
adds complexity to the Tax Code.
Finally, much can be done to simply the Code now even as we
continue to debate and discuss wholesale reform or replacement.
We've submitted 10 suggestions to the Committee and 2 have
been selected for today's discussion. I think they've received
a fairly adequate discussion so far. I'll be happy to respond
to questions on them. The points that we were asked to discuss
are in the supplemental material which I submit for the record.
They involve expensing computer software and the alternative
minimum tax.
We look forward to working with the Subcommittee in making
the tax system a simpler one and welcome your questions.
[The prepared statement and attachment follow. Additional
attachments are being retained in the Committee files.]
Statement of Robert A. Weinberger, Vice President, Government
Relations, H&R Block
Madam Chair and Members of the Subcommittee:
Thank you for the opportunity to discuss tax code
simplification. I'm Robert Weinberger. I was part of the H&R
Block team which prepared the ten simplification suggestions
sent to the Ways & Means Committee and the Treasury Department
in 1997 and 1998. With me is Anita Edwards from Olney, Maryland
who has been an H&R Block tax preparer for the past 22 years
and who can join me in responding to your questions.
About H&R Block
H&R Block, founded in 1955 and headquartered in Kansas
City, is the nation's largest tax return preparation company.
Our 8,800 company-owned and franchised offices are located in
every state. In 1998, we handled 15.6 million individual
returns, which is about 36,000 per Congressional district and
one in seven received by IRS. We originate over half the
electronically-filed returns that the IRS receives from
practitioners. Over 120,000 individuals take our tax training
courses annually. Block Financial Corp. develops and markets
Kiplinger TaxCut tax preparation software with over 1.5 million
users. Other subsidiaries offer financial products and services
including mortgage loans.
Key Points
Before addressing the specific proposals, I'd like to make
four points to put complexity in context:
First, simplicity is often offset by other
important objectives, like fairness;
Second, while preparing tax returns is relatively
simple for most Americans, recent laws are making returns more
complex; complexity is concentrated on high-income and business
taxpayers;
Third, the main reasons for complexity have little
to do with progressive tax brackets; they arise from defining
income, rewarding favored activities, and meeting budget needs;
and
Fourth, much can be done to simplify the existing
code even as we debate wholesale reform or replacement.
First, simplicity is only one of several goals for a good
tax system and it is often balanced against other objectives
such as fairness and progressivity, enforceability, economic
efficiency, and incentives for savings and economic growth. For
example, the adoption credit complicates the code but its
supporters believe it represents the overriding objective of
good social policy. Similarly, indexing capital gains for
inflation, which has been proposed but not adopted and which
Assistant Treasury Secretary Lubick calls ``the mother of all
complexity,'' has support from many advocates of simplicity
because they believe not doing so is profoundly unfair.
Simplicity gets traded off for other goals. What constituency
there may be for simplification usually melts when revenue is
needed or attractive changes are offered, however complex.\1\
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\1\ Simplicity in tax law is hard to achieve. As Judge Learned Hand
wrote over a half century ago, ``In my own case, the words of such an
act as the Income Tax . . . merely dance before my eyes in a
meaningless procession . . . cross-reference to cross-reference,
exception upon exception--couched in abstract terms that offer no
handle to seize hold of--[and] leave in my mind only a confused sense
of some vitally important, but successfully concealed, purport, which
it is my duty to extract, but which is in my power, if at all, only
after the most inordinate expenditure of time.'' Cited in Panel
Discussions on Tax Reform, House Committee on Ways & Means, 94th
Congress, 1st Session (1975), p. 138.
---------------------------------------------------------------------------
Second, preparing tax returns is relatively simple for a
majority of Americans. Without minimizing complexity, it should
be kept in perspective. Millions of low-income Americans are
below the filing threshold. Of 124 million taxpayers who do
file, about 52 million, or 42%, are able to use simple Forms
1040EZ--including 26 million eligible to file by telephone--and
1040A. Only 29% of filers itemize deductions. One survey found
that 45% of all taxpayers spend less than 10 hours per year on
their taxes.\2\ About 80% of income tax filers pay at or below
the 15% marginal rate on taxable income; and two thirds pay
less than a 10% effective rate on their AGI.
---------------------------------------------------------------------------
\2\ Cited in Joel Slemrod and Jon Bakija, Taxing Ourselves (1996),
p. 2. These comments rely on Professor Slemrod's July 12, 1995
testimony before the National Commission on Economic Growth and Tax
Reform. ``For the majority of Americans with an uncomplicated financial
situation, the tax system is not all that burdensome . . . .[M]ost of
the cost of compliance of the individual income tax is borne by a
fairly small fraction of taxpayers.'' Testimony, p. 8. See also
Slemrod's chapter on simplification in Henry J. Aron and William G.
Gale, eds., Economic Effects of Fundamental Tax Reform (1996), ch. 10,
and David Bradford and Joel Slemrod, Making Tax Choices (1996), p. 16-
17.
---------------------------------------------------------------------------
The burden of complexity is focused on businesses,
especially small business (although some accounting and
bookkeeping would be done anyway), and on high-income
individuals, especially the self-employed, who itemize and have
diverse sources of income in the form of capital gains,
dividends, rent, and pension or annuity disbursements. While
over half of taxpayers receive professional help--and
complexity is one reason, many taxpayers do so primarily to
expedite their refund--which 70% receive--or to free more time
for family or other pursuits. Many of us are capable of
changing the oil in our car, but find that paying someone to do
it allows better use of our time.
That picture may be changing. The Taxpayer Relief Act of
1997 is a major culprit--with complex capital gains and IRA
changes and new credits with multiple phaseouts, although it
does simplify taxes on home sales. Similarly, the Alternative
Minimum Tax forms now filed by fewer than 1% of taxpayers will
be required of 6-8% in a decade.\3\ Taxpayers who don't
consider themselves wealthy but take large deductions for
employee business expenses or use tax credits for education,
children, or dependent care may be surprised to find themselves
subject to the AMT. But while these provisions are complex,
they still affect a minority of taxpayers, albeit an
increasing, significant and understandably vocal minority.
---------------------------------------------------------------------------
\3\ See Joint Committee on Taxation, Present Law and Issues
Relating to the Individual Alternative Minimum Tax (``AMT'') (JCX-3-
98), February 2, 1998, and Description of Possible Proposals Relating
to the Individual Alternative Minimum Tax (``AMT'') (JCX-48-98), June
22, 1998. The Taxpayer Relief Act of 1997 contained 36 retroactive
changes, 114 changes effective August 8, 1997, 69 changes effective
January 1, 1998, and 5 thereafter, 285 new sections and 824 amendments
to the Code. It followed legislation in 1996 that made 600 other
changes to the code. On average, since the enactment of the Internal
Revenue Code, major tax legislation has been adopted every 18 months.
---------------------------------------------------------------------------
Third, the main reasons for complexity are defining and
measuring income, subsidizing Congressionally-favored
activities, and squeezing or stretching tax provisions to fit
budget needs. A multi-rate structure may invite complicated tax
minimization strategies, but it is not a cause of complexity by
itself since most taxpayers simply look up their tax in a
table.\4\ Complexity can arise from personalizing and tailoring
tax laws to individual circumstances instead of one-size-fits-
all--a poll tax, for example, is simple but unfair. The Earned
Income Tax Credit could be less complex, but more unfair, if it
were less finely tuned to family circumstances. Complexity can
also arise from defining income. Taxing capital gains and wage
income identically would simplify taxes, but it would also
trade off other objectives such as creating incentives to
invest.
---------------------------------------------------------------------------
\4\ Slemrod 1995 testimony, p. 11: ``An oft-cited cause of tax
complexity is the number of tax brackets. But here one must be careful.
The number of tax brackets per se does not cause substantial
complexity. One of the great red herrings during the debate over the
Tax Reform Act of 1986 was that collapsing 14 tax brackets (15, for
single filers) to three was an important simplification. This is
nonsense, because once taxable income is computed, calculating tax
liability from the tax tables is a trivial operation that is not
perceptibly simplified by having fewer brackets [although a single
bracket would simplify tax administration and withholding].'' See also
Aron and Gale, eds., Economic Effects of Fundamental Tax Reform (1996),
p. 6.
---------------------------------------------------------------------------
Some complexity may be needed to maintain progressivity.
And some may be needed to favor activity that Congress feels is
in the public interest--such as child care, education,
retirement savings, home ownership, charity, or business
R&D.\5\ Budget needs can also influence complexity--phaseouts
and limits on eligibility are sometimes needed to fit the cost
of tax provisions into funds available. Finally, Congress and
the Administration have increasingly found ``targeted'' tax
cuts, credits and deductions more attractive vehicles for
programs than traditional spending through government
agencies--which adds complexity, sometimes for good reasons.
---------------------------------------------------------------------------
\5\ See Slemrod 1995 testimony, p. 2. Another reason deserves
mention: the legislative process involves compromise, splitting the
difference rather than choosing between competing versions, and
pressured drafting that often adds complexity. This may explain the
convoluted calculations that will be needed to take the child credit,
especially for low-income families with 3 or more children. For earlier
examples from the Tax Reform Act of 1986, see Jeffrey H. Birnbaum and
Alan S. Murray, Showdown at Gucci Gulch (1987).
---------------------------------------------------------------------------
Fourth, much can be done to simplify the current code now.
We shouldn't let the debate over more wholesale reform or
replacement of the tax code detract from that important effort.
That is why H&R Block forwarded ten modest suggestions for
simplifying tax provisions that affect average taxpayers in
1997 and 1998.\6\ We're eager to cooperate in improving the
existing code even as we participate in the longer-range
dialogue about broader reforms.
---------------------------------------------------------------------------
\6\ Our 1998 suggestions were prepared by a team in H&R Block's Tax
Training Department led by Rusty Wallower, our late Director of Tax
Research and Information Delivery, and sent to members of the House
Ways & Means and Senate Finance Committees on February 9, 1998. We sent
follow-up correspondence March 13, 1998 and June 2, 1998 about the
opportunity to amend the IRS Restructuring Bill (H.R. 2676) to permit
use of a table in place of complex calculations required by the child
credit provisions of the TRA. The additional information on software
and AMT was prepared by a team in our Education Department led by Karen
Yeager.
---------------------------------------------------------------------------
Much can be done administratively. The IRS presently has a
major effort underway to simplify forms and reduce the number
of notices sent, an effort in which we have assisted. The
Service deserves credit for its efforts to reduce the time and
expense burdens of paperwork for tax compliance.
You've asked us specifically about two of our suggestions--
permitting deductions of non-customized software in the year of
purchase, and modifying or eliminating the individual AMT.
Attached to my testimony are our 1998 Simplification
Suggestions and expanded comments on the software and AMT
proposals. With your permission, I'd like to submit them for
the record along with more detailed examples of the effect of
these laws that were developed by our Tax Training Department
for hypothetical taxpayers.
Simplify Deductions for Business Software
We propose simplifying the purchase of non-customized
software, up to a specified dollar limit, such as $1,000, by
allowing a full deduction in the year of purchase. This is a
good example of a small change that will help millions of small
business owners and the IRS. Current law dictates that most
software of this type be amortized over 36 months. Common
software for word processing, communications, and tax
preparation is usually updated within that recovery period.
This causes additional complexity in recordkeeping and tax
preparation when the deduction, which is usually small, is
claimed over several years. Many taxpayers are unaware of these
rules and fail to comply. The revenue impact would be small
since the costs are eventually written off anyway.
Simplify or Eliminate the AMT
We also propose eliminating the complex AMT for individuals
or minimizing its impact by increasing the exemption and
simplifying rules relating to depreciation and dependents. The
existence of a second, parallel tax system to guarantee that no
one escapes taxation completely because of tax preferences adds
complexity and has the perverse effect of Congress giving
benefits with one hand and taking them away with the other.
In general, AMT income is calculated by adding certain
adjustment and preference items to regular taxable income. One
unnecessarily complicated preference item is the difference
between AMT depreciation and regular depreciation. AMT
depreciation for nonresidential real property is based on a 40-
year life and regular depreciation is based on a 39-year life.
The difference is minuscule but must be calculated by the
taxpayer with non-residential rental property.
I've submitted an example of the AMT effect on heads of
households claiming the child credit, where someone earning
$75,000 may receive more benefit from the child credit than a
similar taxpayer with earnings of $60,000, and several examples
showing the computations and paperwork involved. I've also
submitted several AMT simplification alternatives.
We welcome the opportunity to work with your Subcommittee
to improve the tax system.
Proposals for Eliminating Certain Tax Complexities
Simplify Deductions for Business Software
Proposal:
Allow a direct deduction in the year of purchase of non-
customized software up to a specified dollar limit (such as
$1,000).
Reason:
Often the costs of the software are relatively
small.
The requirement under section 167(f)(1) that software be
depreciated over a 36 month period using a straight-line method
can create a very small deduction. Proposed Sec. 1.167(a)-14
states that the deduction is determined by amortizing the
adjusted basis of the computer software using the straight line
method described in Sec. 1.167(b)-1 (except that its salvage
value is treated as zero) and an amortization period of 36
months beginning with the month that the computer software is
placed in service.
For instance, a $99 software package would result in a $33
deduction if placed in service in January.
Improve Compliance
Many taxpayers are unaware of the requirement to amortize
and out of ignorance fail to comply with the law.
Benefits:
Help small businesses
Small businesses rely on purchased software to meet their
business needs. Under Sec. 167(f)(1) an expense for purchased
software must be deducted over 36 months. If the software
should meet the definition of section 197 property, the expense
would have to amortized over 15 years. The tax compliance costs
and recordkeeping cost are additional burdens for the small
business owner.
Reduces recordkeeping
If the taxpayer can expense the item in the year of
purchase, there is no need for maintaining records over three
years.
Less paperwork
Tax compliance adds additional forms and statements to the
return such as Form 4562, Form 4797, and attachments.
Saves administration costs for the IRS
Allowing an expense for business software in the year of
purchase would save the IRS by reducing costs of input,
handling, storage, and paperwork.
Increase Fairness
Taxpayers who pay to have their tax returns prepared by a
tax professional bear the additional burdens of compliance. The
paid tax preparer will treat the expense properly while the
taxpayer who prepares his or her own return may not understand
these complicated rules and may deduct the entire cost in the
year of purchase.
Simplicity
Deducting software costs below a certain limit will make
tax compliance simpler and easier.
Example:
John Smith owns a small accounting business. In 1998, he
purchased a tax software package for $600 on January 2. He
bought a word processing program for $360 in March and a
utility software package for $99 in February.
In 1997, John purchased tax software for $600.
Effect on Tax Compliance:
John must keep records on each of these purchases.
John would amortize the $600 tax software package over 36
months. Under current law, he would be allowed a deduction of
$200 on his 1998 tax return. John records the amortized
deduction on Form 4562 which he attaches to his tax return
along with a required statement explaining the amortization. He
must keep a worksheet for this asset to record what has been
deducted and what is available for deduction in future years.
The word processing program (costing $360) must be
amortized over 36 months. In 1998, John would be allowed a
deduction of $100. Once again, John must keep records of his
purchase and the deductions claimed. An entry would be made on
Form 4562 to report and deduct the allowed expense and a
statement would be attached to the return.
The utility software package (cost $99) must be amortized
over 36 months. John would be allowed a deduction of $30 on his
1998 return, $33 on the 1999 return, $33 on the 2000 return,
and $3 on the 2001 tax return.
On the 1998 tax return, John may be allowed to deduct the
unrecovered cost of the tax software he purchased in 1997 if he
can prove that it is obsolete. He must file Form 4797 to deduct
the unrecovered cost.
Additional Forms and Paperwork for Tax Compliance:
Form 4562
Form 4797
Amortization Worksheet
Simplify or Eliminate the Individual Alternative Minimum Tax
Proposal:
Eliminate the Alternative Minimum Tax (AMT) for individuals
entirely. Or minimize the impact by increasing the exemption
and simplifying the rules.
Reasons:
Complexity
AMT is a big part of what is wrong with the tax code. IRC
Sec. 56 provides numerous complex adjustments that can
eliminate a tax benefit claimed for regular tax purposes. The
rationale of AMT is to prevent high income taxpayers from
paying little or no income tax due to their ability to utilize
tax preferences. The reality is that many middle income
taxpayers can find their much needed credits or deductions
reduced or eliminated. The law gives a benefit for regular
income tax purposes but takes it away through the complex rules
of AMT.
Schedule A Deductions Can Subject a Taxpayer to
AMT
Large itemized deductions on Schedule A can subject a
taxpayer to AMT.
Employee business expenses can subject a taxpayer to AMT.
Employee business expenses can put an employee at a
disadvantage. Many employees who are not reimbursed for their
business expenses can only deduct these on Schedule A. Often,
these amounts are substantial and the employee loses the
benefit of the deduction because of AMT.
Credits
The Dependent Care Credit can be substantially reduced by
AMT. See the Wayne and Gloria Ambrose Example.
The Child Tax Credit is eliminated for many middle class
taxpayers by AMT limitations. See the Table in Example 1.
The Foreign Tax Credit's interaction with AMT can become so
complex that many tax practitioners (and the IRS) can't
calculate it correctly. Many taxpayers pay substantially more
tax than they owe because they do not understand the AMT
Foreign Tax Credit so they don't claim it on Form 6251. The
taxpayer ends up losing the credit for regular tax purposes.
Benefits:
Simplicity
AMT is a parallel tax system with complicated rules.
Individuals who have taken advantage of certain incentives to
reduce their tax find the complicated rules of AMT can
substantially reduce or eliminate the benefits.
A better way of limiting these benefits may be through
expanded use of the AGI phaseouts available through the regular
tax system. A phaseout can be an effective and simpler method
of limiting benefits to higher income taxpayers rather than the
complicated calculations related to AMT.
Fairness
Many taxpayers do not understand the complexities of AMT.
Many taxpayers who prepare their own returns may ignore the
complex AMT adjustments.
Taxpayers are often surprised when a certain tax benefit is
eliminated by AMT.
It is not just high income taxpayers who are affected by
AMT. Moderate income taxpayers with credits such as the
dependent care credit and the child tax credit can find these
credits reduced by AMT. A review of the table contained in
Example 1 makes clear that a head of household taxpayer earning
$75,000 may well see more benefit from the child tax credit
than a similar taxpayer with earnings of $60,000.
Reduce Recordkeeping
AMT requires parallel recordkeeping for many of the
credits, deductions, and expenses. Taxpayers must maintain the
records even though he or she may not be subject to AMT in the
current tax year.
Reduce Paperwork
Additional Forms, worksheets, and records are required to
comply with the complex AMT rules.
Enhance Compliance
Self-preparers who are unaware of the complex AMT rules
may, through ignorance, avoid providing the IRS with
information needed to correctly calculate their AMT.
Reduce IRS costs
It is difficult to figure out who might be subject to AMT
without auditing a return. Certain AMT adjustments are not
readily apparent from the tax returns. IRS is able to determine
at least partial AMT liability from the tax return and must
design and maintain systems to identify under-calculation of
AMT. If a under-calculation is found, IRS must then notify
taxpayers of their additional AMT liabilities. Many IRS notices
are sent to taxpayers requesting that they complete a Form 6251
only to find that the taxpayer doesn't owe AMT.
Decrease Dissatisfaction with Tax Code
Congress intended AMT to instill confidence in the tax
system by preventing higher income taxpayers from paying little
or no tax. However, the complexity of section 56 increases
frustration with the code.
Examples:
Five examples are provided that demonstrate the current
complexities of AMT. These examples illustrate the following:
Impact of AMT on heads of households claiming a
child tax credit
The volume of forms and paperwork necessary to
comply
The volume of paperwork necessary to calculate the
proper capital gains rate for AMT
The impact of AMT on the calculation of the
dependent care credit.
Example 1--Child Tax Credit Table
Demonstrates the impact of AMT on head of household
taxpayers.
Example 2--Martha Matthews Return
The Martha Matthews return includes six pages of forms that
are required only in order to calculate the foreign tax credit
allowed for AMT purposes. The end result of these calculations
is a $0 AMT tax.
Example 3--Single Taxpayer Return
The Single Taxpayer return includes six pages of forms
required only in order to calculate the correct capital gains
tax for AMT purposes.
Example 4--Nicky Beverly Return
The Nicky Beverly return includes six pages of forms and
worksheets required only in order to calculate the correct AMT
tax. This return also indicates where additional recordkeeping
is required to track:
AMT differences for depreciation and property
basis
AMT credit carryforward.
AMT allowed losses for passive activities.
Example 5--Wayne and Gloria Ambrose illustration
The Wayne and Gloria Ambrose example demonstrates how a
$480 dependent care credit is reduced because of AMT to $23.
The Ambroses itemize their deductions and, for AMT, must add
back part of their medical expense deduction, all of their
state taxes paid and deducted, all of their miscellaneous
itemized deduction amount, and the reduction in cost of stock
purchased through and incentive stock option.
Additional Forms and Paperwork for Tax Compliance:
Form 6251
Form 8801
Multiple Worksheets
Chairman Johnson of Connecticut. Thank you very much for
your testimony, Mr. Weinberger. Thank you all.
I'm sorry that because of the series of votes we're going
to have, we aren't going to be able to get into questions. But
I do appreciate the detail of your testimony and the effort
that you've helped us get started here today. It is a very big
job.
But I think we need to understand what the challenge is of
simplification--both in terms of how to effect it, you know,
how to make it happen and what the revenue costs would be.
Because a lot of the complexity is due to the effort to reduce
the revenue loss of tax benefits or to target those tax
benefits at certain groups of individuals or businesses, so
complexity is the result of policy objectives, but nonetheless
at a certain point that complexity in and of itself becomes a
policy issue. It's perfectly clear from this hearing today that
we are absolutely at that point and we are beginning to
compound our problems through further use of the Tax Code as we
did in the last tax bill. So I do consider this a very
important project even though today's hearing got kind of
jammed in between things. We do appreciate the depth of your
testimony and we invite you to think about what are the next
things we ought to be thinking about.
I do see this as kind of a two-prong operation and one that
will take--will be ongoing. One is clearing the deadwood--
removing obsolete provisions and the other is simplifying key
provisions. Some of the bigger ones are going to take us a long
time, but in the immediate future, we must deal with some of
the problems in the AMT and certainly we do intend to make
change in the marriage penalty.
So thank you very much for your written testimony, thank
you for being with us today. My colleague has no questions and
thank you very much.
[Whereupon, at 4:27 p.m., the hearing was adjourned subject
to the call of the Chair.]
[Submissions for the record follow:]
Statement of Hon. Barbara B. Kennelly, a Representative in Congress
from the State of Connecticut
Thank you, Madame Chair, for allowing me to appear before
the Subcommittee today on behalf of two pieces of legislation I
have introduced which are designed to lessen the impact of the
individual alternative minimum tax on the average family. The
individual AMT was designed to prevent high rollers with
sophisticated tax planners from paying no tax. The problem is
that it has become much more than that. Both of these bills
were made necessary by inattention to detail and a conscious
disregard for fulfilling promises made in the enactment of last
year's tax bill. These problems must be addressed.
Family Inflation Tax
First, my legislation, H.R. 3965, would repeal the family
inflation tax. While the $500 per child credit enacted in last
year's Taxpayer Relief Act will provide vital tax relief to
millions of American families, it will result in a tax increase
for other families.
Did you know that some families, after receiving the
initial benefit, will actually have their taxes increased in
the future because of complicated efforts to reduce the
benefits of the $500 child credit? Yes, that is correct. Over
time, a number of families will see future tax increases even
if their income does not change!
This happens because of the interaction of three
provisions, the partially refundable family credit, the
reduction of the partially refundable family credit by minimum
tax liability and the inflation adjustments to the regular tax.
For some families paying the minimum tax, the inflation
adjustments cause tax increases by increasing minimum tax
liability and thereby reducing partially refundable credits.
Each year, the inflation adjustment of the standard deduction
and personal exemptions--a provision that results in tax
savings for the majority of taxpayers--actually results in a
tax increase for these families. We should not allow this to
happen. That is why I introduced H.R. 3965. Because tax year
1998 is the first year for the $500 per child credit, it is
vital that we fix this problem before returns have to be filed.
On a related note, there is a tremendous amount of
bipartisan support for fixing the marriage penalty. One of the
most popular proposals would increase the standard deduction
for married couples, a proposal that would actually make this
problem with the alternative minimum tax worse. I have been
talking about the need to fix the marriage penalty for years.
We should fix it but we should also include this fix so we
don't increase taxes on families in the name of eliminating a
penalty.
H.R. 2545--to make nonrefundable personal credits, the standard
deduction and personal exemptions creditable against the individual
alternative minimum tax
Second, my legislation, H.R. 2545, would make good on a
promise we made the American people. The Taxpayer Relief Act of
1997 promised American families both an education and a family
credit. Unfortunately for many American families these credits
will turn out to be phantom credits.
Many average families will be thrown into the alternative
minimum tax (AMT) simply because they take advantage of the new
child and education credits. This happens because individuals
pay the greater of regular tax reduced by nonrefundable credits
or the AMT not reduced by nonrefundable credits. And because
both the family and the education credit are added back for
purposes of the AMT, families with children are more likely to
be thrown into the AMT simply by using these credits. In the
case of families with 3 or more children young enough to be
eligible for the family credit, the bill permits the family
credit against the employee share of FICA so that the minimum
tax is no longer a problem for those families. However, it will
be unpleasant surprise for many others.
In 2008, 8 million families will lose the child credit
because of AMT and 3 million families will lose the HOPE credit
because of AMT. For example:
a single mother with 2 children in day care with
$51,400 in gross income would lose all of her child credit plus
$141 of her dependent care credit in the year 2000 because she
gets thrown into the AMT.
a two-parent family with 3 children including one
college freshman and $67,000 in gross income would lose $1,477
of their $2500 combined family and HOPE Scholarship credit
because they get thrown into the AMT.
a two-parent family with 2 children in college and
$64,100 in income would lose $723 of their Hope scholarship
credit because they get thrown into the AMT.
This simply makes no sense! The AMT was meant to assure
that sophisticated taxpayers couldn't zero out their taxes. It
was never intended that your children would throw you into the
AMT.
As some on the Subcommittee may recall, I offered an
amendment during markup of the Taxpayer Relief Act of 1997
which would have made the new child and education credits
creditable against the AMT. While this amendment failed, it was
included in the Democratic alternative. While the Joint
Committee on Taxation has determined that without a change in
the law, the number of individual returns affected would grow
from 605,000 in 1997 to 8.4 million in 2007, this dramatic
growth is not merely the result of inflation, but rather
deliberate policy choices. Simply adjusting the exemption for
inflation would not address the child or education credit
problem.
Therefore, I have introduced H.R. 2524 which would make
nonrefundable personal credits creditable against the
individual AMT and the personal exemption and standard
deduction deductible for purposes of the individual AMT. I
would hope that we could resolve this problem this year before
taxpayers file their first returns claiming these new credits.
And I would hope that we could work to find common ground on
this very serious issue. Thank you.
Statement of National Federation of Independent Business
Madame Chair, the National Federation of Independent
Business (NFIB) is pleased to have the opportunity to submit
the views of its constituents before the Ways and Means
Subcommittee on Oversight.
NFIB is the nation's largest small business advocacy
organization, representing 600,000 members in all fifty states
and the District of Columbia. The typical NFIB member has five
employees and grosses $350,000 in annual sales. Our membership
reflects perfectly the nation's commercial economy--we have the
same representation of retail, service, manufacturing and
construction that makes up the nation's business community.
NFIB sets its legislative positions and priorities based upon
regular surveys of its membership.
Tax Simplification
It is NFIB's position that the only real solution for a
fairer, simpler tax code for all Americans is to scrap the
current code and replace it with one that promotes investment
and savings. We need a tax code that rewards hard work and that
all Americans can understand. For that reason, NFIB applauds
the House of Representatives for voting last week to adopt the
``Tax Code Termination Act'' and looks forward to seeing this
legislation move through the Senate and to the President's
desk.
In the short term, however, there are specific tax
provisions that are particularly onerous to small business. If
Congress has a 1998 tax cut bill, we hope these issues will be
addressed. They are payroll tax reform, death taxes, health
care deductibility for the self-employed, independent
contractor clarification, increased small business expensing,
capital gains simplification, and abolishing the Alternative
Minimum Tax.
Reform Payroll Taxes
First, Congress must reform payroll taxes. One of the
biggest disincentives to job creation for small businesses is
the burden of payroll taxes on both employers and employees. Of
five major tax burdens, payroll taxes were listed as the most
costly tax in the NFIB tax survey, just ahead of personal
income taxes. And 53 percent said payroll taxes are less fair
or much less fair than business income taxes.
One payroll tax is especially burdensome--the Federal
Unemployment Tax, or FUTA tax. Unlike the workers compensation
system, the federal government plays a very significant and
intrusive role in the administration of state unemployment
compensation programs. Washington imposes a payroll tax and
requires enormous paperwork burdens on state governments. Much
of the money that Washington collects from this tax goes to
finance the deficit, not to run the program.
We need to eliminate the FUTA tax and let the states run
the unemployment compensation system. The states have done an
excellent job in taking over control of the old welfare system
(or AFDC), and it certainly makes sense to give them control
over the unemployment system as well.
The effect on small business from eliminating this tax
could help create new jobs by reducing the cost of hiring new
employees. It would also send a strong signal to small business
that Washington understands that payroll taxes are too high and
that strong action is needed.
At the very minimum, Congress should repeal the .2 percent
FUTA surtax that was extended as part of year's tax bill. The
``temporary'' FUTA surtax was enacted in 1976 in order to repay
borrowing of the federal unemployment trust fund from the
Treasury. These debts have been repaid since 1987, yet the FUTA
surtax continues to be collected solely as a means of reducing
the federal deficit NFIB supports full and immediate repeal of
the FUTA surtax.
Eliminate the Death Tax
Although last year's tax bill provided targeted relief, the
death tax continues to be one of the most oppressive taxes on
small businesses and family farms. NFIB considers death tax
reform to be crucial to the continued survival of the small
American family business. Current death tax rates cripple a
small business passed on to heirs, and can force them to
liquidate the very enterprise they have worked in their whole
lives. The death tax may provide government revenue in the
short run, but the long-run costs--a thriving business
extinguished, productive jobs lost, the American dream
diminished--far outweigh the gains.
Small businesses are also particularly vulnerable to the
intricacies of death tax law. Some owners with mobile assets
can ensure a successful transfer to heirs by purchasing life
insurance and through other methods, but many small business
men and women cannot afford this kind of planning. They neither
have the time nor the liquid assets to properly structure their
estate. Unfortunately, unlike a publicly traded corporation,
which continues operation regardless of how shareholders plan
for their death, a closely held business, unless there has been
careful and costly planning, is usually devastated by the death
of an owner.
Furthermore, because all assets are included in calculating
the estate--such as the decedent's home and other personal
assets--many businesses worth far less than the exemption level
become victims of the death tax. Because so many small
businesses operate on cash flow, often with extremely small or
negative profit margins, current law allowing small businesses
to spread their tax liability over fourteen years does not
provide adequate relief.
The 1995 White House Conference on Small Business voted
death taxes as the fourth greatest problem to small business
needing reform. Eliminating the death tax for family businesses
would remove one of the greatest government burdens imposed
upon small family businesses, setting national priorities where
they should be: encouraging the continued operation and
expansion of family business through generations. This issue
will continue to be a priority on NFIB's agenda until it is
eliminated.
100% Deductibility for Self-Employed Health Care Costs
Another area where Congress could build on last year's tax
bill would be to increase health care deductibility for the
self-employed. While the number of uninsured continues to rise,
one way Congress can help ease this is to move more quickly to
100-percent deducibility for the self-employed. Current law
phases the deduction up to 45 percent this year and next.
Unfortunately, full deduction will not be realized by the
self-employed until the year 2007. Small business men and women
cannot put off all their health care needs until the year 2007.
They should not have to wait until then to completely deduct
them either. Congress should be applauded for putting the
deduction on a glide path to 100 percent, but any tax bill
adopted this year should provide immediate 100-percent
deductibility.
Clarify the Definition of Independent Contractor
The current 20 common law factor test for determining who
is an employee versus an independent contractor has for too
long handcuffed small businesses. These instructions are at
best vague and unclear, making it difficult for small employers
to honestly know whether they are complying with the rules.
At the 1995 White House Conference on Small Business the
top recommendation of the delegates was clarifying the
independent contractor definition. In addition, a recent NFIB
Education Foundation Survey of small business owners found that
the issue of determining an independent contractor was one of
the biggest problems facing small business today.
NFIB supports legislation that would clarify the definition
of an independent contractor.
Small Business Expensing
Another positive step taken last Congress was to increase
the annual limit on businesses expensing to $25,000 by the year
2003--less than what was called for in the Contract for
America, but still an improvement.
Expensing is critically important because it: 1) allows
small businesses to escape the complexity associated
calculating depreciation schedules for different pieces of
equipment; 2) reduces cash flow problems by allowing small
businesses to deduct more up front--putting those dollars back
in the hands of business faster; 3) helps the small businesses
who need working capital as well as entrepreneurs looking to
purchase an important piece of equipment; and 4) is good for
the economy--if businesses are allowed to write-off investments
in the year they are purchased, they are more likely to invest,
thereby increasing growth and jobs.
NFIB believes that increasing expensing is the best tool
the Congress has to encourage investment by small and medium
size firms. NFIB supports an immediate increase in the
expensing limit to $35,000.
Capital Gains
NFIB has long been an advocate for reducing the tax on
capital gains to encourage investment and job creation. Last
year's ``Taxpayer Relief Act'' reduced the top tax rate on
capital gains, but only at the expense of simplicity.
The ``Taxpayer Relief Act'' reduced the long-term tax rate
on capital gains from 28 to 20 percent, but it also increased
the holding period necessary to claim a long-term gain from 12
months to 18 months, effectively creating three top tax rates
for capital gains--40 percent for gains on assets held less
than 12 months, 28 percent for assets held between 12 and 18
months, and 20 percent for those held more than 18 months. This
longer holding period has added needless cost and complexity to
the exchange of productive assets, as well as numerous
additional lines to the tax form.
Even with the increased complexity of the three rate
system, last year's capital gain tax cut has been wildly
successful at stimulating economic activity. According to
recent reports, the latest revenue figures show that instead of
losing revenue, as was previously estimated, the tax cut will
actually increase federal collections significantly.
NFIB supports a further reduction in the capital gains tax
rate to 15 percent. In addition, NFIB supports returning the
holding period for long-term capital gains to 12 months.
Abolish the Alternative Minimum Tax for Individuals
Finally, NFIB would like to raise a tax provision which,
although not a burning issue today, is likely to become a major
concern to many small business owners in the near future--the
individual Alternative Minimum Tax.
According to the Joint Committee on Taxation, fewer than 1
in 150 taxpayers is subjected to the AMT today. By 2007,
however, that number is expected to grow to 1 in 14, with the
largest increase coming from taxpayers earning between $50,000
and $100,000. The individual AMT is a remarkably complex and
obtuse provision in a tax code not known for its clarity. It
literally requires taxpayers to calculate their taxes twice,
and then pay the larger amount. While originally designed to
ensure that wealthy Americans pay a reasonable level of their
income in taxes, the AMT has the side effect of hitting
taxpayers--increasingly middle-class taxpayers--when they can
least afford the bill. The AMT literally kicks taxpayers ``when
they are down.''
In 1993 and 1997, Congress made numerous reforms to the
corporate AMT to reduce its complexity and cost to certain
industries. But many small businesses file as individuals, not
corporations. The NFIB supports abolishing the individual
Alternative Minimum Tax. At the very least, the existing AMT
exemption--currently just $33,750 for single filers and $45,000
for married couples--should be increased and indexed to shield
middle-income taxpayers from this onerous tax.
Conclusion
NFIB would like to thank the Madame Chair for this
opportunity to testify before the Ways and Means Subcommittee
on Oversight on the important issue of tax simplification.
There is no greater burden placed on small businesses by
government than that of the tax code, and we look forward to
working with the members of this committee and all members of
Congress to move towards a simpler, flatter tax code.
Statement of Hon. Richard E. Neal, a Representative in Congress from
the State of Massachusetts
Madam Chairwoman, first of all I would like to thank you
for holding this hearing which addresses complexity of the tax
code for individual taxpayers and small businesses. I will
focus my testimony on the complexity of our current tax system
for individuals. Our tax code has become too complicated and I
think it time that we review it and make concrete change to
simplify it. This hearing is a good starting point.
Last year, Congress passed the Taxpayer Relief Act of 1997
which created a whole new host of complexities to the code. The
Taxpayer Relief Act added about 320 pages to the tax code. The
new provisions are complicated because of the different
effective dates and eligibility requirements. The new tax bill
will cause more individuals to be thrown in the alternative
minimum tax (AMT) and this will result in many taxpayers not
being able to take advantage of the newly passed credits.
Present law imposes a minimum tax known as the alternative
minimum tax (AMT) on an individual taxpayer to the extent the
taxpayer's minimum liability exceeds his regular tax liability.
The AMT imposes a lower marginal rate of tax on broader base of
income. Since 1969, some form of the AMT has been in place. The
purpose of the AMT is to have individuals with some measure of
economic income to pay at least a minimum amount of tax.
Under present law in 1998, 848,000 taxpayers will pay the
AMT and this is 0.8 percent of taxpayers. In 2008, 8,822,000
taxpayers will pay the AMT or 7.2% of all taxpayers. A reason
for this expected increase is personal exemptions, standard
deduction, and tax brackets are indexed for inflation and the
AMT is not indexed for inflation.
Last year's new bill created many new credits which
benefited families, such as the child credit and the HOPE
Scholarship credit. When calculating the AMT, the family credit
and the education credit are added back. In the next few years,
many families will not be able to receive benefits of the
credits. The disallowance of credits can begin with income
limits as low as $42,350.
Rep. Kennelly and I have introduced legislation which would
make nonrefundable personal credits (dependent care, child, and
education credits) and the standard deduction and personal
exemption deductible for AMT purposes. We have also sponsored
legislation to repeal the family inflation tax. The $500 per
chid credits enacted in last year's Taxpayer Relief Act will
provide tax relief to millions of American families. However,
some families will face a tax increase.
Due to the interaction of three provisions, for some
families paying the minimum tax, the inflation adjustments
cause tax increases by increasing minimum tax liability and
thereby reducing partially refundable credits. The three
provisions are the partially refundable family credit, the
reduction of the partially refundable family credit by minimum
tax liability and the inflation adjustments to the regular tax.
The two bills just described fix problems that were
exacerbated by the Taxpayer Relief Act. I think this Committee
should look at both of these proposals thoroughly. These two
proposals would help working families take full advantage of
the new tax credits.
Recently, I introduced H.R. 4053, legislation to simplify
the computation of taxes for individuals. This legislation
would replace two worksheet schedules with a total of 19 lines
and replace them with one line.
This legislation simplifies the individual income tax by
repealing the adjusted gross (AGI) limitation on itemized
deductions and the personal exemption. Under current law,
personal exemptions are reduced by 2% for each $2,500 which the
AGI of the taxpayer exceeds $181,000 for joint filers and
$121,200 for single filers. If an individual's adjusted gross
income exceeds $121,200, certain otherwise allowable deductions
are reduced by the lesser of 3% of the excess of adjusted gross
income over the applicable amount, or 80% of the itemized
deductions otherwise allowable for the tax year.
This legislation repeals the complicated provisions
described above and replaces them with an additional income tax
of 1.59%. The bill simplifies the calculation of current
phaseouts and removes the marriage penalty of these provisions.
In order to remove the marriage penalty the new additional
income tax will affect individuals with lower AGI. The
additional income tax of 1.59% applies to individual taxpayers
with adjusted gross income of $75,000 for individuals and
$150,000 for joint filers. These thresholds are indexed for
inflation. This additional tax does not apply to estates or
trusts. This legislation is effective for taxable years
beginning after December 31, 1998.
This legislation is revenue neutral. The purpose of this
legislation is to make it easier for individuals to compute
their taxes and to remove unfair marriage penalties included in
phase-out provisions. This legislation is a start to
simplifying the tax code. We should be reviewing the code and
simplifying many proposals. This hearing should provide useful
information to pursue this task.
Statement of Hon. Jim Ramstad, a Representative in Congress from the
State of Minnesota
Madame Chairman, thank you for convening this important
hearing on the tax code complexity affecting small businesses
and middle-income taxpayers.
I don't need to recite the statistics that show how complex
our tax code is. There is ample, painful evidence.
For small business entrepreneurs, who represent 99.7% of
employers, employ 53% of the private work force, contribute 47%
of all sales and 50% of private gross domestic product to our
nation's economy, tax complexity is a special burden.
Small businesses have been crushed not only by high taxes,
but also by mountains of tax paperwork. Small corporations
spend over seven times what they actually pay in income taxes
just trying to comply with our hopelessly complex tax code.
This discourages investment, robbing small businesses of the
opportunity to grow and create new jobs.
And middle-income taxpayers, who will increasingly be
pulled into Alternative Minimum Tax calculations, will soon be
facing the ultimate complexity nightmare.
Again, Madam Chairman, this is a critically important
hearing. Thank you for your leadership in bringing attention to
these issues.
Statement of White House Conference on Small Business
The undersigned are the elected Regional Chairs of Taxation
representing the 2000 delegates to the White House Conference
on Small Business. We were delegated the responsibility of
advancing implementation of the conference's recommendations
with regard to the tax issues and reporting progress back to
the delegates. As the Ways and Means Committee prepares to
consider tax policy issues, the delegates to the White House
Conference on Small Business want to remind you of the
important tax issues for the growth and progress of small
businesses in America.
Simplicity
The single largest concern of the White House Conference on
Small Business was dealing with the overall complexity of
government and the complexity of the tax code in particular.
Allocating and reporting income taxes and payroll taxes is the
one common experience of every business and may be the only
interaction which most businesses have with the federal
government. Simplifying the tax process would, therefore,
improve the situation for every small business. Studies have
shown that it costs small businesses more to comply with the
tax code, and considerably more in comparison to each dollar of
sales, than it costs large businesses. Small businesses have
fewer sales over which to spread the cost.
One of the major recommendations of the White House
Conference was that Congress should concentrate on creating a
simpler and fairer tax system. Within the context of the
current tax code, four of the top White House Conference
recommendations called for simplification of rules that are
complex and frightening for small businesses:
Clarification of the definition of an independent
contractor. We will not expand on it today, except to say that
it continues to be a source of concern for small businesses.
Testimony was previously submitted on this subject.
Immediate deduction of healthcare insurance
premiums for the self employed.
Repeal of the estate tax.
An increased expensing allowance (in lieu of
depreciation) under IRS 179 for equipment purchases for small
businesses.
Each of these recommendations was born out of the
frustration accompanying a tax code which is perceived as
complex and unfair. Studies have shown that it costs many small
businesses more money to comply with the tax record-keeping and
reporting obligations than it costs to pay the taxes
themselves.
100% Health Care Deduction for the Self-Employed
We were pleased that Congress approved an eventual increase
to 100% deductibility, but were disappointed that the increase
will be phased out in over 10 years. This desire was in line
with the White House Conference recommendation that the tax
deductible amount be raised immediately to 100% and be
deductible prior to the calculation of the self employment tax.
Although there is some tax cost, the increase helps serve the
policy goal of providing health insurance to as many people as
possible. When there is little or no tax incentive for
employers to buy health insurance for themselves and their
families (note that 1.4 million children of self-employed
individuals have no health coverage), they are likely to decide
to forgo offering it to their employees as well. In other types
of businesses, C-corporations for example, the health insurance
premiums of the principals in the business are already fully
deductible. We feel tax based decisions should not be
substituted for sound business judgment in the selection of
business structure. If a tax bill is considered in 1998, we
urge Congress to include this proposal as a matter of equity
for all business people.
Estate Tax Reform
One of the strongest recommendations of the White House
Conference on Small Business was a call for the repeal of the
estate and gift tax. The Taxpayer Relief Act of 1997 included a
provision which provides some help for a qualifying small
business (in cases where the value of the small business is
over half of the gross estate.) While this is welcome relief,
more needs to be done to protect businesses from being
dismantled at the death of the principal. The passage of a
small business from one generation to the next has a positive
impact on the community, promoting stable employment, long-term
community support of community groups, and an active interest
in maintaining the quality of education and life in the
``neighborhood.''
If outright repeal is too costly under the budget
requirements, we feel that proposals which provide for
continued reduction of the tax and the administrative burden on
small businesses would be helpful. By focusing the legislation,
Congress can provide relief directly to farms and small family
businesses while foregoing a relatively small amount of
revenue. The Congress should adopt a tax policy that moves the
country toward the positive goal of sustaining the economic
vitality of a small business and away from a policy which
requires expensive and complex estate plans and insurance. The
reality today is that elaborate and costly estate plans often
must be undertaken, which drains assets from productive
business investment. Without such plans, there is no guarantee
that the business will last to serve the next generation of
owners or workers.
Expensing
The expensing limit of IRC Sec. 179 will be gradually
increased to $25,000 (by the year 2003) from its current level
by the Small Business Job Protection Act passed by Congress in
1996. We appreciate the attention Congress gave to this issue,
but would urge greater increases and quicker implementation.
Expensing is perhaps one of the most useful tax simplifiers for
small business; however, its use still remains limited. In
addition, Congress did not correspondingly raise the $200,000
limit on purchases. These days, one piece of machinery (even
for a very small business) can exceed this limit, effectively
eliminating many small businesses from any benefits. Finally, a
technical correction added to the bill changed the definition
of small business property from IRC Sec. 1245 property
depreciable under IRC Sec. 168 to add the requirement that the
property qualifies under IRC Sec. 38 retroactively to 12/31/90.
This retroactive change imposes a burden on small businesses
which had made investment decisions based on existing law.
Software Expensing & the Year 2000
One area where we, the Regional Chairs for Taxation of the
White House Conference on Small Business, feel Congress could
make a tremendous contribution is to allow expensing in the
year a business purchases software obtained for business
purposes. It is practically impossible to declare with
certainty what the useful life of software is within a
business. With the pace of technology, useful life gets shorter
and shorter as better products which exploit hardware advances
seem to hit the market continuously.
Particularly troublesome are the problems caused by the
year 2000 (Y2K) which many small businesses do not fully
understand. The cost to them to upgrade their software and
hardware might be considerable. We believe it serves public
policy to provide incentives to help small businesses assess
their exposure to the problem and purchase new software as soon
as possible. This will insure the continuity and free flow of
business in 2000.
In 1996, the Gartner Group estimated that the year 2000
problem would cost $600 billion to fix. Later estimates by
Lloyds of London have been as high as $1 trillion. Economist Ed
Yardeni has estimated that there is a 35% chance of a global
recession because some businesses will be unable to deal with
their year 2000 problems. And, unlike most projects, the final
due date can not be changed with the year 2000 problem--the
year 2000 will arrive whether we are ready or not.
The Federal Reserve is currently predicting that 1% to 7%
of US businesses will fail because of the year 2000 problem.
The Board is encouraging all businesses to address the problem
as early as possible. The Small Business Administration and the
Department of Commerce are encouraging all small businesses to
make plans to assess the situation now so that actions can be
taken in a timely manner. Many of the affected businesses will
need new items of software and hardware, and we would urge that
the materials immediately be deemed able to be expensed.
Summary
In general, the White House Conference urged Congress to
investigate a simpler, fairer tax system but purposely did not
specify what changes should be made. The Conference also
suggested a number of specific changes which we hope the
Committee will continue to consider. We would like to recommend
that any changes that are considered be analyzed for their
impact on small businesses and that representatives of the
small business community be included in future hearings on the
subject.
We would like to work with you, your colleagues, and your
staff to help you better understand the importance of these
proposals to small businesses and the U.S. economy. Thank you
for your time and attention to this matter.
Sincerely,
THE WHITE HOUSE CONFERENCE TAX
CHAIRS
Region 1 Debbi Jo Horton,
Providence, Rhode Island
Region 2 Joy Turner, Piscataway, New
Jersey
Region 3 Jill Gansler, Baltimore,
Maryland
Region 4 Jack Oppenheimer, Orlando,
Florida
Region 5 Paul Hense, Grand Rapids,
Michigan
Region 6 Joanne Doherty, Houston,
Texas
Region 7 Edith Quick, St. Louis,
Missouri
Region 8 Jim Turner, Salt Lake City,
Utah
Region 9 Sandra Abalos, Phoenix,
Arizona
Region 10 Eric Blackledge,
Corvallis, Oregon
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