Rules are simplified, but the effects vary by the household

12:00 AM CST on Sunday, November 27, 2005

By PAMELA YIP / The Dallas Morning News

President Bush's tax reform commission achieved its goal of coming up with a simpler federal return.

The plan would allow taxpayers "to actually understand what you're paying tax on," said Wayne Shaw, an accounting professor at Southern Methodist University's Cox School of Business.

But whether you like the proposals is likely to come down to whether it's your ox being gored.

The panel shortened the tax form by eliminating most deductions and credits, saving only those that would encourage certain behaviors, such as saving, charitable giving and homebuying.

"Every deduction in the ... [Internal Revenue] code helps someone, and there's an industry that's grown up around that deduction," said Mark Luscombe, principal federal tax analyst at CCH Inc. in Riverwoods, Ill.

Some of the most radical changes would come to the alphabet soup of savings plans – including 401(k)s, individual retirement accounts and health savings accounts – which would disappear. In their place, consumers could choose from "Save at Work," "Save for Retirement" and "Save for Family" plans.

The advisory panel's proposals will form the basis of recommendations made to Mr. Bush by Treasury Secretary John W. Snow.

Mr. Bush will then use the Treasury Department's proposals to craft legislation to submit to Congress. Treasury officials said there's no specific timeline on when Mr. Snow will submit his proposals.

What are the chances of the various proposals surviving?

Those who see themselves hurt by the proposed system are likely to have a bigger impact on its fate, fighting hard to prevent it from being enacted, said Mr. Luscombe.

"Many others might feel little pain," he said, "but will they be as passionate in favor of the reforms just to save time and energy filling out their returns?"

Under the proposed changes, those with simple tax situations should be relatively unscathed.

"As long as you're a generic taxpayer, you seem to come out all right," said Phillip Schwindt, senior research analyst at CCH.

CCH provides tax and accounting services to tax professionals.

"But if there's something special about your situation, you could get hammered," he said.

Also, the proposed elimination of the itemized deduction for state and local taxes, including property taxes and income taxes, could hurt many homeowners and those who want to buy a house.

The change would make homeownership more expensive on an after-tax basis.

Still, in many cases, people would pay about the same tax as they do now, CCH said in an analysis of the report released this month by the President's Advisory Panel on Federal Tax Reform.

"But many of them would be people whose taxes are simple to begin with," the group said. "They may take the standard deduction and not have to grapple with itemized deductions, the alternative minimum tax, and supplemental schedules and forms."

Mr. Schwindt, who calculated scenarios of taxpayers at various income levels, gave an example.

A married couple with two children and an adjusted gross income of $50,000 who took the standard deduction and don't have child-care expenses would pay $150 less in tax under the proposals.

"But if they currently have $6,000 in child care expenses and use the dependent care credit, their tax bill would climb by $1,050 under the proposal," Mr. Schwindt said.

The panel presented two plans as possible replacements for today's bloated, complex system: the Simplified Income Tax Plan, which is the chief recommendation, and a Growth and Investment Plan.

The proposed changes are sweeping.

Under each plan, the standard deduction, personal exemption, child credit and all itemized deductions would disappear.

They would be replaced by a "family credit" and a "home credit" based on mortgage interest paid on a principal residence, up to certain limits.

All taxpayers – regardless of whether they itemized – could deduct their charitable contributions in excess of 1 percent of their income.

"People who are deducting the full amount will complain, but people who took the standard deduction but were making large charitable contributions would be able to get the deduction," said Bob D. Scharin, a tax attorney and editor of Warren, Gorham & Lamont/RIA's Practical Tax Strategies, a monthly journal for tax professionals.

The earned income tax credit, which benefits the working poor, would be replaced by a work credit, but a host of other credits for individuals and businesses would disappear.

About the only significant fringe benefit left standing would be employer-provided health care, but even some of that would be counted as taxable income if plans exceeded certain limits.

The dreaded alternative minimum tax, which is trapping more middle-income taxpayers, would disappear.

The legion of tax-advantaged education and retirement savings vehicles under the current Internal Revenue Code would be replaced by three savings plans.

Under the Simplified Income Tax Plan, there would be four tax brackets: 15 percent, 25 percent, 30 percent and 33 percent. Currently there are six brackets.

Dividends from U.S. corporations wouldn't be taxed, and 75 percent of capital gains from U.S. companies would be excluded from income, producing effective tax rates from 3.75 percent to 8.25 percent. Interest would continue to be taxed at ordinary income rates.

The Growth and Investment Plan proposes three brackets for individuals: 15, 25 and 30 percent, with dividends, capital gains and interest all taxed at the lowest rate, currently 15 percent.

"Taxpayers with investment income, especially long-term capital gains and dividends, generally would do better under the Growth and Investment Tax Plan, while those primarily with wage income would do better under the Simplified Income Tax Plan," CCH analysts said.

The panel's three streamlined savings plans are intended to boost the savings rate, at least in part through simplifying how the programs work.

Save at Work accounts would replace 401(k)s, SIMPLE 401(k)s, thrift plans, 403(b) plans, SARSEPS and SIMPLE IRAs. They would follow the current contribution limits and rules for 401(k)s.

To stoke employee savings, the reform panel recommends automatically enrolling employees in the savings plans and giving them the choice to opt out.

Save for Retirement accounts would replace traditional IRAs, Roth IRAs, nondeductible IRAs and other retirement savings vehicles.

Workers would use Save for Retirement accounts to supplement their Save at Work accounts.

Taxpayers would be able to save up to $10,000, or the amount of earnings if less, in the tax-free plans. Contributions would be made with after-tax dollars and earnings would grow tax-free.

The tax reform panel has recommended indexing the annual contribution limit for inflation.

Because the panel didn't propose income limits, which exist for many current savings plans, Save for Retirement accounts would be open to all taxpayers.

Save for Family accounts would replace Coverdell Education Savings Accounts, 529 college savings accounts, Archer Medical Savings Accounts, health savings accounts and flexible spending accounts.

Contributions would be made on an after-tax basis, and earnings would grow tax-free if they're used for medical costs, education or training expenses, and purchases of a primary home.

In addition, consumers who are 58 or older could withdraw the money tax-free.

All taxpayers would be able to take out up to $1,000 tax-free each year for any purpose. However, amounts exceeding $1,000 that weren't used for health or medical costs, education or training expenses, or for a home purchase would be taxed an additional 10 percent.

Consumers also would be able to use Save for Family plans to supplement their retirement savings.

E-mail pyip@dallasnews.com