How negotiations may affect tax reform

No matter what happens in the debt ceiling negotiations over the next week, elements of potential tax reform are emerging.

Details are sketchy, but here are some potential changes that would affect financial advisers and their clients:

TAX RATES

The Gang of Six proposal would simplify the tax code to three individual rates in the following brackets: 8%-12%, 14%-22% and 23%-29%. It also would establish a single corporate rate be-tween 23% and 29%.

TAX EXPENDITURES

In order to achieve the lower rates outlined above, the Gang of Six plan calls on Congress to “reform, not eliminate, tax expenditures for health, charitable giving, homeownership and retirement, and retain support for low-income workers and families.”

Other tax expenditures, such as tax deferrals for the buildup of cash value in insurance plans, also would be on the table for elimination or reduction.

BUSH TAX CUTS

A so-called grand bargain to raise the debt ceiling might include provisions to let the 2001-03 tax cuts implemented by the Bush administration expire at the end of 2012. The Bush reductions lowered individual rates and provided a raft of other deductions.

ALTERNATIVE MINIMUM TAX

Under the Gang of Six plan, Congress would repeal permanently the alternative minimum tax.

CAPITAL GAINS/DIVIDENDS

Although not explicitly mentioned in debt ceiling agreements so far, experts said that the tax rate for capital gains and dividends, currently 15%, almost certainly would have to rise if Congress lowered individual rates and broadened the tax base.

Of course, the Gang of Six proposal may fall to the wayside during negotiations due to strong opposition from conservatives and liberals.

A so-called fallback plan proposed by Senate Majority Leader Harry Reid, D-Nev., and Senate Minority Leader Mitch McConnell, R-Ky., would allow Mr. Obama to raise the debt ceiling in increments between now and the end of 2012, while implementing about $1.5 trillion in spending cuts.

The Reid-McConnell plan, which does not have an explicit tax reform dimension, is the “more likely” vehicle to raise the debt ceiling, according to an analysis by Keefe Bruyette & Woods Inc., a financial services firm. — Mark Schoeff Jr.