TAX DIVISION
OF THE
AMERICAN INSTITUTE OF
CERTIFIED PUBLIC ACCOUNTANTS
COMMENTS ON
H.R. 5166
THE TAX SIMPLIFICATION ACT OF 2002
DECEMBER 5, 2002
AICPA COMMENTS ON H.R. 5166
TABLE OF CONTENTS
Page
INTRODUCTION1
TITLE I – ALTERNATIVE MINIMUM TAX2
Sec. 101. Repeal of Alternative Minimum Tax2
TITLE II – FAMILY-RELATED PROVISIONS2
Subtitle A – Qualifying Child and Family Status2
Subtitle B – Other Family-Related Provisions6
Sec. 211. Acceleration of Repeal of Phase-Out of Personal Exemptions6
Sec. 212. Acceleration of Repeal of Phase-Out of Overall Limitation on Itemized Deductions 6
Sec. 213. Repeal of Certain Phase-Out Provisions6
Sec. 214. Simplification of Capital Gains Tax7
Sec. 215. Exemption of Certain Interest and Dividend Income
from Tax8
Sec. 216Simplification of Deduction for Points on Home Mortgage8
Sec. 217. Increase in Exclusion for Group-Term Life Insurance
Purchased for Employees8
TITLE III – EDUCATION-RELATED PROVISIONS8
Sec. 301.Uniform Definition of Qualifying Higher
Education Expenses8
Sec. 302.Combining Hope and Lifetime Learning Credits9
Sec. 303.Clarification of Interaction of Various Education
Tax Incentive Provisions9
TITLE IV – BUSINESS PROVISIONS10
Sec. 401. Cash Method of Accounting10
Sec. 402. Repeal of Collapsible Corporations10
Sec. 403. Simplification of Active Business Test for Certain
Corporate Reorganizations11
Sec. 404. Study on Simplification of Attribution Rules11
Sec. 405. Clarification of Treatment of Contributions of Intangibles
to Corporations and Partnerships12
AICPA COMMENTS ON H.R. 5166
TABLE OF CONTENTS (cont’d)
Page
Sec. 406. Modernization of References to General and Limited
Partners12
Sec. 407. Repeal of Ability to Elect Large Partnership Reporting
Rules12
Sec. 408. Repeal of Personal Holding Company Tax12
Sec. 409. Timing Rules for Guaranteed Payments13
Sec. 410.Secretarial Authority to Prescribe Class Life for Property13
Sec. 412.Consolidation of life Insurance Companies with Other
Companies Permitted13
TITLE V – ESTIMATED TAX14
Sec. 501. Failure to Pay Estimated Tax Penalty by Individuals
Converted to Interest Charge on Accumulated Unpaid
Balance14
TITLE VI – REPEAL OF DEADWOOD PROVISIONS14
Sec. 601.Repeal of Deadwood Provisions14
1
INTRODUCTION
The American Institute of Certified Public Accountants (AICPA) has long been an advocate of simplifying the tax system. We commend Representative Rob Portman on the initial draft of H.R. 5166, The Tax Simplification Act of 2002, andare pleased to have the opportunity to offer our comments. This bill does an excellent job of focusing on many areas of tax law in need of simplification. We look forward to the re-introduction of the refined legislation during the 108th Congress.
We believe now is the time to take decisive action to simplify the Internal Revenue Code. As H.R. 5166 proposes, Congress should first repeal the alternative minimum tax for both individuals and corporations; then, simplify and harmonize the definitions and qualifications associated with filing status, dependency exemptions, and credits. Finally, the inconsistent phase-outs that make tax planning difficult for individuals and result in confusing marginal rates should be eliminated. These changes alone all of which are contained in H.R. 5166 will make the Code more consistent, rational, fair, and transparent, particularly for low- and middle-income taxpayers.
In addition, the AICPA agrees that other areas where Congress might concentrate simplification efforts to reduce complexity for a broad range of taxpayers include: (1) simplifying capital gains taxation; (2) harmonizing and simplifying the education incentives; (3) repealing the collapsible corporation provisions; and (4) rationalizing the estimated tax safe harbors.
While there are revenue costs associated with simplification reforms, it is also important to recognize that there are significant compliance burdens that will be eliminated by such reforms. We appreciate Rep. Portman’s leadership in this important area.
The following pages detail our constructive comments on most of the recommendations in H.R. 5166. This bill provides a clear starting point for the task ahead. We urge Congress to follow its blueprint and free the many adversely affected taxpayers from the hidden tax burden imposed by the Code’s complexity.
TITLE I – ALTERNATIVE MINIMUM TAX
Sec. 101. Repeal of Alternative Minimum Tax
The AICPA supports the repeal of the individual alternative minimum tax. The AMT no longer serves the purposes for which it was intended. Legislative changes implemented since its enactment have been effective in more closely conforming the regular tax base for individual taxpayers to the AMT base. Further, the narrowing of the differential in tax rates between the regular tax system, leaving the AMT largely to trap “ordinary “ taxpayers with little or no amounts of tax preferences.
The AICPA also believes that the corporate alternative minimum tax should be repealed, because it suffers from the same infirmities as the individual AMT.
TITLE II – FAMILY RELATED PROVISIONS
Subtitle A – Qualifying Child and Family Status
Although we believe that H.R. 5166’s provisions for a uniform definition of child is an excellent starting point, the legislation can be improved and public acceptance more readily gained by incorporating the following comments, taken from the recent Tax Simplification Recommendations Report, dated September 13, 2002, jointly issued by the AICPA, the American Bar Association Section of Taxation, and the Tax Executives Institute.
Relationship Test
We agree that siblings and stepsiblings and their descendants should be included in the definition of qualifying relationships for the child tax benefits. Today’s unconventional households, driven in part by expensive rental housing, often find siblings, nieces, and nephews sharing the same living space and residing as part of the same family unit. In many instances, these individuals play an important role in rearing a child.
However, H.R. 5166 states that only “a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of any such relative, whom the taxpayer cares for as the taxpayer’s own child” meets the relationship test. The provision includes a backdoor support test, because “caring for” the child would require a showing of such activities as purchasing food, clothes, school supplies, toys, medical care, entertainment, etc., as well as paying rent for the premises in which the child and the taxpayer reside. As a general matter, H.R. 5166 rejects “support” as a part of the “qualifying child” definition and the “care for” requirement is vague and hard to administer (how many weekend outings or birthday gifts are necessary to meet the test?); therefore, we recommend simply including siblings, step-siblings and their descendants in the general description of qualified relationships and eliminating the “care for” language. We believe that the residence and tiebreaker rules (which give first priority to the child’s parents in the case of dual claims) would avoid any abuses of including these relationships as qualified.
In addition, H.R. 5166 proposes including other individuals who live with the taxpayer during the year and who are members of the taxpayer’s family. This provision narrows eligibility by requiring the individual to be a member of the taxpayer’s family. Current law allows individuals who are members of the taxpayer’s household. We suggest continuing to use that the current language, which takes current living arrangements into consideration.
Residence Test
Dependency Exemptions: Tradability
Under H.R. 5166 the dependency exemption, like the other child-based benefits, will be awarded based on a showing of residence rather than support. This is a dramatic shift from existing law. H.R. 5166 further states that the dependency exemption cannot be released to a non-custodial parent except in the case of grandfathered child support agreements. This non-tradability feature is also included in the Study of the Overall State of the Federal Tax System and Recommendations for Simplification, prepared by the Staff of Joint Committee on Taxation and issued April 2001 (JCT Study).
We disagree with this approach. Divorcing couples should continue to have the ability to bargain over the dependency exemption. Although making the dependency exemption tradable would complicate H.R. 5166, we believe that eliminating the tradability feature will add significantly greater complexity to divorce proceedings. Under H.R. 5166, non-custodial parents who pay substantial, non-deductible child support would be deprived of any benefit from these expenditures, even though their tax-paying ability is clearly affected and the custodial parent may receive no benefit from claiming the dependency exemption. Of course, if the parties have not voluntarily assigned the dependency exemption between them, we agree that the custodial spouse is the proper recipient of the benefit.
We recognize that permitting tradability would undermine the uniformity of the qualifying child definition. However, we believe this additional complexity is warranted given the additional economic burden imposed by eliminating this flexibility on families with dependent children who are already financially burdened by divorce. Non-tradability might also create audit issues where none would exist under current law because the recipient of the dependency deduction was designated under the support agreement.
Shared Physical Custody of the Child
Under H.R. 5166, a custodial parent with whom the child resides would receive all the child-based benefits. As a result, determining which parent is the custodial parent becomes increasingly important in shared-custody situations. Under current law, when both parents have claimed the EITC with respect to the same child,or where one parent claims the EITC but the child does not reside with that parent for the full year, IRS audits require the parents to reconstruct the number of days each spent with the child during the year to determine the availability of the EITC and/or who is the proper claimant. Because parents normally do not keep contemporaneous records of days spent with their children, this can be quite challenging.
Even if the child’s visitation history is readily available, determining how to count days can be exceedingly complex. Issues include: (1) what constitutes a day, including the day in which the child moves from one parent’s household to the other’s; (2) how to count days that the child visits relatives or stays in friends’ homes; (3) how to count days the child is in school and both parents are working; (4) what happens if both parents spend time with the child on shared holidays, vacations, or days spent jointly taking the child to camp or school; (5) how to count days when the child resides at the taxpayer’s house, but the taxpayer is out of town.
By making all child-based benefits, not just the EITC, turn on more than six months residency with the taxpayer, H.R. 5166 puts added pressure on counting days. Additional guidance on this subject is needed.
To reduce disputes, we specifically recommend including safe harbors, such as the following:
- If one parent has been awarded physical custody of the child, the child should be presumed to be a qualifying child as to that parent unless the presumption is rebutted by evidence that the child spent at least 183 days of the year with the non-custodial parent (the “six-month test”).
- If the parents have been awarded joint physical custody and the child does not satisfy the six-month test with respect to one parent, the child should be treated as a qualifying child with respect to the parent who claims the child-based benefits, provided the other parent does not also claim the child-based benefits.
- If the parents have been awarded joint physical custody and the child does not satisfy the six-month test with respect to one parent, the child should be treated as a qualifying child with respect to the parent that has the higher AGI.
We also suggest clarifying that, for this purpose, a parent’s income is determined without regard to the income of a spouse with whom that parent may file a joint return. These safe harbors should not restrict the custodial parent from relinquishing the right to treat the child as a dependent to the other parent, as under current law.
Age Test
H.R. 5166 does not recommend changing the age tests [most frequently 13, 17, 19, or 24] for the various child-based benefits under existing law. Although reducing the number of different ages involved would offer additional simplification (e.g., using the same age limits for the child credit and the dependency exemption), we recognize that revenue constraints may preclude streamlining the qualification thresholds.
Continued Use of the Support and Gross Income Tests in Certain Cases
Although relegated to a significantly reduced role in H.R. 5166, the support and gross income tests would continue to be used to permit dependency exemptions for siblings, aunts, uncles, parents, and certain others. We agree with this more limited use of the support and gross income tests.
Unrelated Children as Dependents
H.R. 5166 would require a taxpayer to care for a foster child “as the taxpayer's own child” in order for the foster child to qualify under the uniform definition, even though the bill would require placement by a state-authorized agency to be considered as a foster child. Although the care requirement is useful when no state involvement is required to classify a child as a foster child, we believe the care requirement is unnecessary if the category is restricted to state authorized placements. Therefore, we believe the care requirement should be omitted.
Public Benefits
We support not taking public assistance payments by government agencies into account in cases requiring a support test. Including the public benefits as support would be extremely difficult to administer. Determining how to value benefits such as Medicaid or Section 8 housing subsidies (the latter are granted on a sliding income scale) would be difficult, if not impossible. In addition, low-income taxpayers who spend all their disposable income on their children simply would not understand a rule which said that they did not support the child for tax purposes.
Household Maintenance Test
The household maintenance test is a secondary support test that, under current law, applies to head-of-household filing status and the dependent care credit. Under this test, the taxpayer must prove that she or he maintained a household where the child resided, by showing that the taxpayer paid rent, made mortgage payments, paid for repairs, or otherwise maintained the household.
We recommend that eliminating this test for both the dependent care credit and head-of-household filing status. This would reduce complexity by avoiding the confusion that would necessarily result from taxpayers believing they are entitled to head-of-household status simply because they have a qualifying child. In addition, we believe head-of-household filing status denotes family status, not a financial test.
Conclusion
We support H.R. 5166’s plan to adopt a uniform definition of “qualifying child,” And believe the following modifications will improve H.R. 5166 and aid in gaining public acceptance:
- Eliminate the requirement that the taxpayer care for siblings and stepsiblings and their descendants “as the taxpayer's own child.”
- Continue to allow tradability of the dependency exemption as under current law.
- Provide guidance on conventions for counting days to determine periods of residency and consider creating safe-harbors.
- Continue to use the support test for siblings, aunts, uncles, disabled adult children, and parents, along with other specified household members.
- In light of the requirement for state authorized placement of foster children, eliminate the requirement that taxpayers “care for” a foster child “as the taxpayer's own child.”
- Eliminate the household maintenance test for purposes of qualifying for head-of-household filing status as well as for purposes of the dependant care credit.
Subtitle B – Other Family-Related Provisions
Sec. 211. Acceleration of Repeal of Phase-Out of Personal Exemptions
The AICPA strongly agrees with the proposal to accelerate the repeal of the phase-out of the personal exemptions. See discussion below.
Sec. 212. Acceleration of Repeal of Phase-Out of Overall Limitation on Itemized Deductions
The AICPA strongly agrees with the proposal to accelerate the repeal of the phase-out of the overall limitation on itemized deductions. See discussion below.
Sec. 213. Repeal of Certain Phase-Out Provisions
To accomplish the diverse goals implemented in the Internal Revenue Code, many Code sections “phase out” enumerated deductions and credits over various income ranges based on differing measures of taxpayer income. Currently, these phase-out ranges are not consistent, either in defining income, the applicable levels of income, the range of income over which the phase-out applies, or the method of applying the phase-outs. The phase-out ranges even differ depending on filing status, and these differences are also inconsistent.
For example, the deduction for contributions to a traditional IRA phases out over a different range of income [defined as adjusted gross income (AGI) modified for adoption assistance, tuition deductions, and student loan interest, foreign income and EE bond interest exclusions] for single filers than it does for married-joint filers. In contrast, the $25,000 allowance for passive losses from active participation rental activities phases out over the same range of income for single and married-joint filers. In some cases, more than one phase-out must be addressed, involving multiple – and often interdependent – computations.
Phase-outs complicate tax returns immensely, result in a lack of transparency in the tax law, and impose marriage penalties. Phase-out instructions are difficult to understand and the average taxpayer cannot manage the complex calculations. In addition, the differences in phase-out methods and definitions of income impose a compliance burden on many individuals and make it difficult for taxpayers to recognize when they are eligible for a benefit and when and how any phase-out applies. Tremendous income-level differences also exist across the various programs using phase-outs.
As it stands, some phase-outs are so complicated that neither the targeted taxpayers nor those charged with explaining and administering the rules are able to accurately understand and interpret them.