TIME FOR TAX REFORM
OK, another tax filing deadline has come and gone. We are all exhausted with the constant gathering of this, saving of that, record keeping of your stuff, your spouse’s stuff, your kids stuff, e-filing or mailing and then trying to figure out what to do with all the support stuff you just gathered to file the blasted tax return. Dare I say it is a GIANT HASSLE filing an annual US individual tax return? But what if filing could be different?
The system is wacky and many profit from this dysfunctional system – I am one of those capitalist who do - so hooray capitalism (One of our business operating segments is preparing taxes). Why can’t filing be easier? Why have we created such a diabolical system that requires us to gather and collate documents to report information the tax people in many cases already have (copies of many form are sent to the IRS and others). There has got to be a better way.
Do other counties have it better?
Several stories have been written about Japan, Germany, and the UK regarding how these nations have a “return-free” filing system for many taxpayers. Some go so far as to let the tax agency file for them. Others send you information on what was filed in your name and you only respond if you disagree. Sounds great, but we have all seen way to many movies about corruption and skullduggery to the point where we can’t possibly trust OUR government to do such a thing.
Of course we have all heard these other countries pay outrageous percentages of their income in taxes. A 2013 KPMG study quoted by Henry Blodget, disclosed a taxpayer with taxable income of $100,000 in Japan, Germany and UK paid about 16%, 29% and 24% respectively. At the same time the rate on US income was approx 22%. Of course when Social security taxes are factored in these percentages approximate 35%, 45%, and 37% respectively with the US coming in at 32% *
Most Agree the Current System Really Needs Change
Taxes are one of the items that almost everyone disdains, with each of us having some interesting bias or another. In a 2015 study citizens identified corporations and the wealthy as social loafers not paying a fair amount of taxes (this study included Republicans, Democrats and Independents). On average over 63% felt corporations did not pay a fair amount and 60% said the wealthy were just as guilty in failing to pay a fair amount of tax. To sum it all up over 44% of respondents said the tax system was too complex. **
The bottom line is we are headed for some type of tax reform. Congress is gearing up for reform and the public is ready. Many expect a tax cut, will we get it? For most of us the reform will impact our personal tax return - The infamous IRS form 1040.
To Solve the Problem We Will Likely - “Round Up the Usual Suspects”
The most likely sacrificial tax items will be our itemized deductions. These deductions appear on the mighty Schedule A which details all of your favorite itemized deductions. You know the form – the tax form which allows you to deduct your state income taxes paid, real estate property taxes, mortgage interest and charitable deductions. Schedule A is one of many forms which require you to scrounge around looking for the documented information to plug into the requisite boxes to rightfully, by law reduce your tax burden.
Many have realized itemized deductions do not result in a dollar for dollar reductions in income taxes, the amounts simply reduce the tax due based upon and in proportion to your tax rate. A simplistic example can be seen here - Billy Ray Bob has itemized deductions of $10,000 his tax rate is 20%. Billy Ray Bob’s taxes are reduced by $2,000. The $10,000 out of pocket spending saved $2,000 in income taxes.
I’ve often heard a taxpayer say “if I find another $1,000 of deductions, my taxes would go down $1,000 right” – sadly, I give them the bad news about deductions and tax rates. The conversation goes something like this “Billy you have a tax rate of 20% which means the additional $1,000 of deductions will reduce your tax obligation by $200” – then I wait for the sigh at the other end of the line.
Given that backdrop, here is where I think we are headed with tax reform - a bigger/larger standard deduction and fewer taxpayers filing schedule A.
Currently in 2016 the tax system is set up as follows: Mr. & Mrs. Taxpayer have the choice of deducting a standard deduction of $12,600 or collect and add up all your itemized deductions and if your Schedule A itemized deductions (state income taxes paid, real estate property taxes, mortgage interest and charitable deductions) are greater than $12,600 you can deduction the larger of the two.
Mortgage interest is by far the largest itemized deduction for most taxpayers. However, since 2002 the dollar amount of mortgage interest deductions for taxpayers continued to be smaller and smaller and here’s why.
(1) Mortgage rates have dropped from about 6.5% to 4% or less. This means your mortgage payment is lower and so is your interest deduction. On a $300,000 home that could be $6,500 less in deductions and at a 20% tax rate this equates to a $1,300 increase in federal taxes (we have not even considered the impact on state tax),***
(2) Fewer and fewer people own homes. Home ownership peaked in 2005 and has continued to decline to its lowest rate in 2016. A minor uptick was shown recently, however younger people want flexibility and are more mobile, thus a home is not practical, ****
(3) Apartments - Why are all these apartments/senior housing being built? Many older Americans want out of their homes and will not be able to sell the Mc Mansions built in the 70’s and 80’s. These seasoned Americans want a simple life as they get older, not a more complicated life.
(4) Homes are just not that cool anymore - Add to this the sad reality – your kids do not want those Mc Mansion monstrosities either -too much upkeep, too much space and they are just too much everything. What will baby boomers do with these homes? Enter the long hated, misunderstood, soon to be much needed government program of reverse mortgage to the rescue – but I will save that for another article.
All that being said the mortgage interest deduction is dying a slow death.
Why not just put home mortgage interest out of its misery along with the hassle of Schedule A and other itemized deduction by increasing the standard deduction! By The Way - less than 31% of American taxpayers itemize or use Schedule A. *****
How about a standard deduction of $20,000, $30,000, $40,000 or $50,000 for married couples? How about a sliding standard deduction based upon your family adjusted gross income? This modification would do several things (1) create no tax deduction benefit of most home ownership, (2) would eliminate a lot of busy work for taxpayers gathering tax documents and (3) would temper the behavior modification of the tax code (many people bought homes as a tax dodge, not cause they wanted a house) as well as remove some discrimination which benefits homeowners.
If such an idea is floated, there will be a great hue and cry from the public due to the emotional attachment to the deduction. The real estate and mortgage lobby groups will be lining up with money to vilify congress with ads and at the same time dole out reelection contributions to sway any votes for this proposition. I can’t wait to see what happens!
Last year my itemized deductions were in excess of $30,000 and it took way too much time to pull all the information together to compute the deduction. I am sure I spent many hours gathering documents, getting receipts, going through check on-line register reports (I use Mint and have a great bank and credit card reporting). Then I had to review the results again to check to make sure the information was correct and save the data as PDF’s on the cloud. Personally, I would welcome a sliding increased standard deduction, how about you?
* Global Tax Rates http://www.businessinsider.com/america-taxes-charts-2013-1
** Pew Research Wealthy and Corporations pay too little - http://www.people-press.org/2015/03/19/federal-tax-system-seen-in-need-of-overhaul/
*** Mortgage Interest rates - http://www.bankrate.com/finance/mortgage-rates-history-0112.aspx
**** Home ownership - http://www.tradingeconomics.com/united-states/home-ownership-rate
***** What percent itemizes - https://taxfoundation.org/who-itemizes-deductions/
Round up the usual suspects - https://www.youtube.com/watch?v=HXuBnz6vtuI (one of my all time favorite movie scenes)
Jerry Lee | 04/24/2017