Last week was the 150th anniversary of the US income tax. Originally established to fund the Civil War, the Federal income tax underwent various changes, with the basic system we have today being established in 1913. It seems appropriate, on this anniversary, to note that we can expect to see some significant changes in the structure of the income tax code later this year.
Although the recent Budget Control Act of 2011, Washington’s last-minute solution for the extension of the debt ceiling, includes no specific changes in tax laws, there is a good chance that the second round of deficit reduction mandated by the law will actually produce significant tax changes.
The act provides a strict timetable under which a Joint Select Committee (JSC) on Deficit Reduction must develop a plan for $1.5 trillion in deficit reduction. The plan must be voted on by both houses of Congress by December 23, 2011. If the bipartisan committee fails, an automatic round of across-the-board budget cuts will take place starting in 2013. The automatic cuts, split 50-50 between defense and domestic spending, are designed to be so unpalatable to all sides that a consensus on some other solution will be forced.
Under current law, the Bush-era tax cuts are set to expire without further Congressional action at the end of 2012. Congress has not yet provided patches to the Alternative Minimum Tax beyond the end of 2011, and the configuration of the estate and gift taxes after 2012 need to be addressed at some point as well. These latter two may or may not be included in the JSC’s proposal, but if the proposal fails, the expiration of the Bush tax cuts would produce $1 trillion in reductions automatically.
It will be difficult for the JSC to develop a proposal that does continues the tax code (as it currently exists) beyond 2012. Moreover, given the relatively short period of time during which the JSC’s work must be completed, there is growing speculation that it will need to make use of tax proposals that have been made previously this year by one of three groups: the President’s Fiscal Commission, the Debt Reduction Task Force, or the bipartisan “Gang of Six.”
Among the changes thought likely are:
- reductions of some kind in various key tax deductions, including deductions for mortgage interest, charitable giving, state and local taxes, and medical expenses
- simplification of the tax rate structure, with the possibility of a top tax rate lower than the present 35%
- repeal of the AMT
- less-favorable treatment for dividend and capital gain income
One change proposed by the Gang of Six would alter the calculation of inflation adjustments to the tax code by using the “chained CPI,” an index that would produce a lower inflation calculation than the present method. Since the Joint Committee on Taxation determined that the tax burden of this change would be borne primarily by middle and lower-income taxpayers, it’s unlikely to be among the solutions chosen, but we’ll have to wait and see.
The one certainty? Since Congress is likely to wait until the last minute provided by the Act to finalize its legislation, it seems almost a given that taxpayers will not know the final layout of any tax changes that will take effect until the very end of 2011.
So be prepared for some swift year-end tax planning execution right after Christmas. And have a Happy Income Tax Anniversary!