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Will tax reform cost you? 5 ways to tell

By Richard Barrington

Will tax reform cost you? 5 ways to tell

Taxes are such a hot-button topic that even the language of taxation is sensitive. What sounds like tax reform or simplification to some people comes off as code for tax increases to others.

Differences over tax policy are more than just perception, because there will be winners and losers from any changes in the tax code. In fact, because of the huge national debt, tax changes are a less-than-zero-sum game, meaning that winners and losers won't cancel each other out: when all is said and done, there will be a net price to pay in order for federal income taxes to address the national debt.

Prominent tax proposals

There are endless possibilities for federal income tax reform, but here are three major themes:

  1. Simplification of the federal income tax code. This means getting rid of loopholes in the corporate tax code, and reducing the number of tax deductions available to individuals.
  2. Adjusting federal tax brackets. An oft-mentioned trade-off for reducing loopholes and individual deductions is that it would enable tax rates to be lowered in at least some federal tax brackets. This was the essence of the Reagan tax reforms in the 1980s - tax rates were lowered in exchange for simplification which reduced many loopholes and deductions.
  3. Raising taxes on high incomes. Traditionally, taxpayers with the greatest financial means have been expected to shoulder a greater proportional share of the tax burden. The tax cuts under George W. Bush lowered high-income tax rates, but President Obama has proposed restoring higher tax rates for top income brackets.

 

Naturally, there are divisions between the political parties on each of these issues and on the extent to which deficit reduction should be accomplished via tax changes or spending cuts. In fact, there are even divisions within each party about both the tax and spending sides of the equation. So, whatever legislation does come through will probably be the result of extensive horse-trading on the above and other points.

5 signs that tax reform may cost you:

While the final nature of tax reform is far from settled, based on the types of initiatives being discussed, here are five criteria you can look at to tell if tax changes are likely to cost you:

  1. You have large deductions. It is uncertain which deductions will be the ultimate targets for elimination, but the more federal income tax deductions you have - both in number and dollar amount - the more likely you are to see them eliminated to some degree.
  2. You make over $250,000 a year. There's no magic to that number, but in general, higher tax rates are most likely to target the highest federal tax brackets.
  3. You own a subsidized business. Tax subsidies for things like ethanol have come under fire, so if you benefit from this kind of subsidy, you are at risk of losing these benefits under tax simplification.
  4. You own a complex business. Given the outrage over the ability of major corporations such as General Electric to dodge taxes, you might see changes in accounting rules which affect the ability of corporations to take advantage of things like lease-purchase arrangements or allocating profits to foreign subsidiaries.
  5. Your parents are very rich. 2010 was a good year to die - at least, from a tax standpoint. Estate tax rules were relaxed temporarily in 2010, but they are back in 2011. Some proposals would stiffen estate tax rules further, either via the dollar threshold at which estates become taxable, the tax rates on those estates, or both.

The bigger picture: get ready to pay

The above outline identifies where the greatest burdens of tax reform are likely to fall, but given the deficit problem, it is inevitable that the cost will have to be spread pretty broadly among American taxpayers. In fact, perhaps the only thing worse would be the cost to financial stability of failing to address the deficit.

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Richard Barrington has earned the CFA designation and is a 20-year veteran of the financial industry, including having previously served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc. Richard has written extensively on investment and personal finance topics.

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