Will We Ever Have Tax Reform?

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Let’s try to put some things into perspective. Governments have always needed revenues. So we pay taxes, and in the words of Supreme Court Justice Oliver Wendell Holmes, “taxes are what we pay for a civilized society.” Yet most of us discuss taxes with a noticeable amount of distaste if not distrust of the tax code and how it applies to each of us individually, if not collectively. We find the news relating to tax law changes captivating as well as frustrating.

The first income tax was passed in 1861 to fund the Civil War and it expired in 1872. There were a few attempts after that to re-implement an income tax, but it wasn’t until 1913 that the Sixteenth Amendment was finally ratified. Changes began shortly thereafter and so much so it seems we have a change every couple of years. The last significant change occurred in 1986.

However, on January 1, 2013, the House and Senate passed the American Taxpayer Relief Act of 2012, ushering in a new year and a new round of changes. Much of the Act was to make permanent the extension of the 2001 Tax Relief Act (EGTRRA), which had been temporary for twelve years.

The issues that seems to escape the wrangling and horse trading in Washington are the balanced budget and the deficit. Most of us know that to balance a budget either income must grow, expenses must decrease or both. Since the federal government is the only government entity allowed to operate at a deficit (as opposed to states, counties, cities and school districts), their collective sense of urgency apparently doesn’t match ours.

Raising enough revenues can only be done by altering the tax brackets – including more taxpayers and/or changing brackets; and/or eliminating tax breaks; or both. For example: if the value of your employer-provided health insurance was taxed it could add $184 billion to revenues federally and $250 billion in payroll taxes. And if the mortgage interest deduction were eliminated another $100 billion in taxes would be collected. (The Burden and the Benefit by Bruce Barlett, 2012, p. 97-98).

Since we know that the tax code is the result of social engineering colliding with special interest groups wrestling with congressional leaders seeking favor and reelection, it seems doubtful that any meaningful change will occur in the near future. By the end of the first quarter of 2013 the next fiscal emergency may well be upon us.

There is some good news that resulted from the American Taxpayer Relief Act. The Alternative Minimum Tax is patched for 2012 and permanently adjusted for inflation going forward. The estate tax exemption amount is kept at $5 million and inflation adjusted. More closely to home, the relief from cancellation of debt income for principal residences (short sales) has been modified to include tax year 2012, and tax-free distributions from IRA to charity now also include tax year 2012.

Although it may be many years if ever that we see true tax reform, it is vitally important for us to be aware of tax implications on our income and savings as we plan for our future retirement. This is another reason why working with an advisor may be able to help you in not only building, but also maintaining your hard-earned nest egg.

Please Note: We suggest that you discuss tax issues with a qualified tax professional.

 

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