Many of us have spent the past month or so watching the government shutdown, the debt ceiling debate and the rollout of the Affordable Care Act. The can was essentially kicked down the road with respect to the shutdown and debt ceiling debate. The hopes for a grand bargain have quickly dissipated and no one has much clarity as to what, if anything, will come out of the upcoming negotiations when these items are again taken up for consideration in both houses of Congress.
The White House is currently preoccupied with getting the rollout issues with the ACA fixed, so one may wonder what focus there is on the budget deficit and debt ceiling issues. There is agreement in some circles that there needs to be some level of comprehensive tax reform. What any reform actually looks like is where it gets murky. Many agree there needs to be a focus on changes that encourage job creation and economic growth. There is some agreement, though not universal, that corporate tax rates must become more competitive with the tax rates used by our major trading partners. The current Federal corporate rate of 35 percent is 10 points higher than some of our largest trading partners including the U.K., Canada and even China. The U.K. continues to reduce its corporate tax rate each year; the rate is scheduled to be at 20 percent in 2015. Thus, in 2015, the U.K. corporate tax rate will be approximately half of the combined Federal and state corporate tax rate in the U.S.
Corporate tax reform has received some attention in Washington. Some of the discussion has centered on reducing tax rates and “paying” for this reduction by changing rules for deductions for certain types of expenses. Additionally, many tax provisions expire at year end, including the research tax credit and some depreciation incentives for fixed asset purchases. If these provisions are not renewed, many business taxpayers will see an increase in their actual cash taxes paid in 2014 and beyond. If past experience is an indicator, the expiring provisions will be renewed in some fashion near the end of 2014 with an effective date to the beginning of the year. Of course, a tax reform deal or some horse trading within the budget or debt ceiling debate could change all of this.
On the individual tax side, many higher taxpayers may have a big surprise when April 15 rolls around. For taxpayers with long-term capital gains and dividend income, the federal tax rate jumped from 15 percent in 2012 to 23.8 percent in 2013, a nearly 60 percent jump in the actual amount of tax that is tax due if similar amounts of income were earned in 2012 and 2013. In addition, any ordinary income earned in 2013 also has seen an increase in the top federal tax rate. The federal tax rate on ordinary income has jumped from 35 percent to as high as 43.4 percent, a 24 percent jump in the amount of tax paid if similar amounts of income were earned in 2012 and 2013.
These tax rate changes take into account the additional Medicare tax on investment income being used to finance the ACA. A stumbling block in Washington appears to be what to do with individual tax rates in the context of any tax reform discussion. The rates were increased for 2013 as previously mentioned. Many on one side of the aisle are of the opinion that the tax rates are not high enough, even with the recent tax rate increases. The thought is a number of taxpayers are not paying their fair share. Others on the other side of the aisle are of the opinion that the rates are likely too high and the focus should be on broadening the tax base by reducing loopholes or changing limiting certain deductions.
Providing advice to taxpayers in this environment is often difficult as there is not clear visibility into the future. The soap opera in Washington moves from one crisis to another and repeats itself with no clear resolution in sight. In some respects, the situation resembles a continuous prime-time miniseries and the plot is predictable. Many may believe this soap opera is actually a horror movie and there is no super hero to save the day.
If I look into my crystal ball, the probability of comprehensive tax reductions is very remote given the current environment in Washington. Any tax reform will likely have a break-even approach with some winners and losers, since the base revenues are needed to fund the government. The addition of Obamacare and some of its uncertainties may impact future revenue needs. The uncertainties include: how many will sign up for the exchanges; the amount needed to fund the expansion of Medicaid; and the amount needed for individual and business subsidies.
Reining in all government expenditures is important for the financial stability of the government and the country. The auto industry and the city of Detroit have seen the impact of large future commitments on their respective financial situations. Bankruptcy was the option for two of the automakers and for Detroit. Given the recent drama in Washington, such an ending is not so improbable anymore for the Federal government.
There is some good news in our personal tax situations. There are still several weeks before the end of the current tax year for individuals. Some planning may assist to reduce the impact of the 2013 tax rate increases so the shock and awe of April 15 doesn’t overwhelm them. Individuals should review their income and deductions for 2013 and the impact of any planning on both regular and alternative minimum tax liabilities. Many may benefit from capital gains (realized and unrealized) from the stock market run in 2013. As discussed in a prior column, the unrealized gains may present an opportunity. The transfer of certain qualified appreciated property to a qualified charity may provide a way to avoid taxation on the unrealized gains and at the same time receive a charitable itemized deduction for the gift. Any actions regarding any yearend tax planning should be reviewed with a professional adviser. Some planning for yearend can avoid a horror story April 15.
William Roth is a tax partner with the local office of BDO USA LLP. The views expressed are those of the author and not necessarily of BDO. The comments are not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult their professional advisers before acting on any items discussed herein.