To Be or Not to Be?
The Future of Taxes Proves Elusive

By Jay Dismukes

During a presidential election year, gauging the tax landscape may seem like an exercise in futility. However, the implications of certain tax items—both proposed and in place—on a fragile yet hopeful economy and an expansive deficit perhaps necessitate a look around the bend.

As reported in last month’s Trusted Professional, the alternative minimum tax (AMT) has been grabbing headlines and the attention of an increasing number of Americans falling into it, all of which has resulted in the introduction of several bills designed to fix it. Society members interviewed for the story pointed out that, despite the legislative efforts, AMT reform is severely complicated by the billions of dollars in revenue the tax generates each year.

Seemingly less difficult for lawmakers to address, though, is the Section 179 deduction and the phaseout for eligible property.

Under the 2003 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), small businesses can immediately deduct the first $100,000 of machinery and equipment purchased rather than depreciating the cost over the remaining useful life. At the same time, the limitation on the annual amount of qualifying property purchased increased from $200,000 to $400,000. After 2005, the expensing limit will revert from its $100,000 level back to the previous $25,000 cap, as will the annual total of deductible property. CPAs believe a return to the prior limit could be significant to growth on many levels.

NYSSCPA Tax Division Oversight Committee member James B. McEvoy pointed out that the change to the tax law likely has prompted many savvy businesses with additional funds to buy equipment now that they might not even need at the current time just so that they can enjoy the large, upfront deduction.

“In terms of the manufacturing process in the U.S., that could hurt because people would order less equipment until they actually needed it,” McEvoy said, referring to the possibility of the limit falling back to $25,000 in 2006, unless Congress acts.

Alan Frankel, also a member of the Tax Division Oversight Committee, thinks that the increased write-off has led to companies investing more on capital additions, especially on technology. He hopes that Congress decides to keep the expensing limit at the current level or negotiate an amount between $50,000 and $100,000.

McEvoy also thinks that the reduction in tax rates on dividends, sheared from 35 percent to 15 percent for most taxpayers and 5 percent for taxpayers at lower income levels, has “slowly but surely proven to be a great stimulus to the economy.” I. Jay Safier, a member of last year’s NYSSCPA Tax Simplification Task Force, said his clients have been very enthusiastic over the 15 percent dividends tax, but the relief has helped put more of them in the AMT, thereby nullifying some of the benefits on the reduced tax rate. The new dividends rates are set to expire on Dec. 31, 2008.

JGTRRA’s changes to capital gains tax rates have been a boon to job growth, McEvoy added. The maximum capital gains rate dropped from 20 percent to 15 percent, while the 10 percent rate for lower income taxpayers dipped to 5 percent. Unless made permanent, these older rates will be reinstated in 2009.

Frankel, a partner with Frankel Loughran Starr and Vallone LLP, is less certain about the ability of the rate cuts to put “juice back into the economy.” He noted that the cuts primarily benefit the nation’s wealthiest individuals, who he thinks likely use the extra money to increase their brokerage accounts. The middle class, he said, would be more apt to spend their tax savings.

These cuts are just a few of the many that President Bush would like to see made permanent. This, of course, includes complete repeal of the estate tax, which is scheduled to take effect in 2010. The tax would reappear in 2011 for estates of individuals with assets of $1 million or more.

Though they believe an exemption in the neighborhood of $2.5 million to $5 million is likely to occur, none of the practitioners interviewed for this story believe that the federal estate tax will ever be repealed.

While the push for making provisions of the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA) and JGTRRA permanent will depend on who is elected president, the Congressional Budget Office (CBO) estimates that, if enacted, they would come at a price tag of approximately $1 trillion in lost revenue over 10 years. The CBO, in September, projected a $422 billion deficit for 2004 and a $348 billion deficit for 2005, if current laws and policies don’t change.

The math, according to Safier, just doesn’t add up, especially given the nation’s war on terrorism and efforts to stabilize Iraq and Afghanistan.

“We have big deficits. I don’t see us being able to go income neutral. It seems to me you have to generate dollars in order to support our actions all over the place,” Safier, a partner with Weinick Sanders Leventhal and Co. LLP, said. “I don’t see the tax cuts being permanent in that respect. If you’re going to make them permanent, somewhere else you’ve got to pick up the difference.”

If elected president, John Kerry has called for the rollback of tax relief for households with incomes of $200,000 or more. Safier said he doubts this could happen unless Democrats regain control of Congress. Frankel added that individuals making $200,000 or more who are also in the AMT haven’t been able to enjoy the full benefit of the rate reduction anyway. Efforts to increase marginal rates, therefore, should also be tied to AMT reform, he said.

Though he, like many, believes the AMT is riddled with problems, the tax-deferred growth opportunities that accompany Bush’s proposed lifetime savings accounts hold some interest for Frankel. So too does the proposed Social Security personal savings account option for McEvoy. The higher interest rate that could result from investing in a bond, for example, is an advantage to the option, he said. Still, McEvoy cautioned that there could be downsides to the proposal.

“The problem with investments is that you just don’t know how they are going to do, whereas with Social Security, you have some idea of how it will do,” said McEvoy, who runs his own firm, James B. McEvoy, CPA.

Most experts do not foresee Congressional action on these accounts anytime soon. For the immediate future, however, four cuts in individual income taxes are scheduled to expire at the end of 2004: the expanded 10 percent tax bracket, the higher child tax credit, the marriage penalty relief, and the temporary increased exemption for the AMT. The House of Representatives has passed bills on each of these provisions, which currently await action in the Senate.