WASHINGTON - Some financial advisers are disappointed that the President's Advisory Panel on Federal Tax Reform didn't go farther than it did in advocating sweeping reforms, even though some proposals are considered by others as too controversial to be enacted.
"This is tampering with the current system, and not true tax reform as the president, I think, asked for,'' said Scott Neal, a certified financial planner who is president of D. Scott Neal Inc., a registered investment advisory firm in Lexington, Ky.
He and some other advisers would like to see the country replace the income tax system with a national sales, or ad valorem, tax, an idea that the tax panel considered but rejected.
"I had expectations that they were going to come out with some sort of major simplification,'' commented Gerald Weiss, a CFP and enrolled agent who is a principal of RIA firm Weiss Tax and Financial Specialties in Reno, Nev. "I'm disappointed."
"I was hoping for something even larger - a proposal for a flat income tax or the national sales tax route,'' said Shannon Lunsford, a CFP and president of Lunsford Financial Planning Inc. of Louisville, Colo. "This is a minor simplification."
Still, the tax reform panel came up with two options for major income tax reform. Treasury Secretary John Snow said that the Treasury would consider the recommendations, and hopes to come up with tax reform legislation by the end of the year.
Both plans presented by the panel would eliminate the alternative minimum tax. Without congressional action, 21 million taxpayers will potentially be subject to that tax next year. Both plans would simplify the current jumble of exemptions, deductions and credits that are subject to different definitions, limitations and eligibility.
Both plans would abolish the current tax-free status for the inside buildup in life insurance policies and annuities, which would be a huge loss to the life insurance industry. Instead, savings for retirement would be funneled into save- for-retirement accounts, which would be limited to $10,000 annual contributions. There are currently no limits on what can be put into annuities.
The proposals also would eliminate the ability of some taxpayers to save tax free through the use of executive deferred-compensation plans.
Both the Simplified Income Tax Plan and the Growth and Investment Tax Plan are similar in their treatment of households, but they would differ in their tax treatment of businesses and investments.
The Simplified Income Tax Plan would reduce the top tax rate from the current 35% for individuals and businesses to 33% and 31.5%, respectively. The Growth and Investment Tax Plan would cut the top rate to 30% for both individuals and businesses.
At the press conference in Washington last week, at which the report was released, the panel handed out 5%BD;-by-8%BD; inch, 32-line sample income tax forms that could be used to replace the current 75-line 1040 tax forms.
What will probably be the most controversial proposal of both plans would replace home mortgage interest deductions, which are now available only to itemizers, with tax credits available to all taxpayers for 15% of mortgage interest. The credit would be capped at interest paid on the average regional price for housing, which ranges from some $227,000 to $412,000.
Responding to comments that the proposal is a "non-starter," panel chairman Connie Mack, a former Republican U.S. senator from Florida, said at a press conference in Washington last week that "those who have concerns about individual pieces of this ... really should look at the entire package that we're proposing, not just one single part of it."
Fewer than 5% of mortgages in the United States are for more than the average retail prices, Mr. Mack said. Further, "the majority of the benefit from the present treatment of mortgage interest deductions goes to the very high income," he said, adding that less than 30% of American taxpayers benefit from it. Under the proposal, all homeowners with mortgages would be able to take advantage of the deduction.
Panel vice chairman John Breaux, a former Democratic U.S. senator from Louisiana, noted that eliminating the AMT would result in losses to the U.S. Treasury estimated at $1.3 trillion over 10 years. "That was an easy thing to recommend," he said at the press conference. "But then you have to find revenues under the president's directive to make it revenue neutral as to how to offset that."
The present mortgage interest deduction system also skews investment decisions, Mr. Mack said. Corporate America pays a marginal tax rate of about 24%, while business in general pays 17%, he said. However, "the number for real estate is somewhere between zero and 4% or 5%, and some would argue it might be even less than that."
But Dave Moran, a certified financial planner who is senior vice president of Evensky & Katz Wealth Management, an RIA firm in Coral Gables, Fla., argued that opting for a tax credit instead of deductions could give homeowners an incentive to elect interest-only mortgages, because tax credits are worth more than deductions.
Still, he applauded the emphasis on eliminating the AMT and said that he believes that the report will give further impetus to dealing with that looming tax problem.
Some advisers welcome the proposals because they support economic theories of more-efficient allocation of resources and financial decision making.
A major change advocated by the panel would be to eliminate the tax-free status of employer-provided health insurance, which is an attempt to make people more conscious of the costs of health insurance and push them to shop for more economical health care. In place of the current exemption, all taxpayers could buy health insurance with pretax dollars, up to the amount of the average premium, currently $11,500 for a family.
State and local taxes would not be deductible under either proposal, which is sure to be unpopular in high-tax states such as New York and California.
Save at Work
Under the Simplified Income Tax Plan, 100% of dividends from U.S. companies paid out of domestic earnings would be excluded from taxation, which would eliminate "the double tax on corporate profits," commented Michael Kitces, a CFP who is director of financial planning at Pinnacle Advisory Group Inc. in Columbia, Md. Under the Growth and Investment Tax Plan, dividends would be taxed at a 15% rate.
The panel also took another stab at simplifying tax-favored savings plans, reminiscent of President Bush's proposal for simplified savings accounts. Under the proposals, save-at-work plans would allow initial tax deductions and tax-free earnings withdrawals to replace employer-provided defined contribution plans such as 401(k)s.
Save-for-retirement plans would replace individual retirement accounts with non-deductible accounts to which people could contribute as much as $10,000 per person, up from the current IRA contribution levels of $4,000 a year. Like Roth IRAs, withdrawals could be taken tax free at retirement.
Save-for-family plans could be used for all other types of savings, including popular Section 529 education savings accounts. Up to $10,000 per person could be put in those accounts, which could be withdrawn only for retirement, education, home purchases or health care.
The life insurance industry fought against the president's earlier proposal for lifetime savings accounts, which could have been withdrawn tax free at any time, for any reason, and which could have resulted in fewer sales of annuities by life insurers.
The American Council of Life Insurers in Washington isn't any happier with this plan. "They're recycling a proposal that's gone nowhere fast," said ACLI executive vice president Greg Jenner. "What they're trying to do is say, 'We recognize LSAs were very unpopular, because it was a revolving-door savings plan. We're going to put a patch on it and try and fix the problem.' It doesn't really."