Improving Taxation In The United States

The federal income tax, payroll taxes, and gift and estate taxes in the United States don't collect enough from affluent individuals and businesses and is too complex for most taxpayers, while its most recent iterations of eliminated some tax breaks that are important for fairness. This post lists some of the changes that would be beneficial. It also lists a handful of suggestions for state and local taxation and the Medicaid program that are related to these reforms. 

Limited Liability Entity Taxation

* Tax all limited liability entities, all complex trusts, and all publicly traded partnerships, except tax exempt entities and RICs and REITs, as corporations. 

* Repeal the check the box regulations and establish transition rules for legacy S-corporations and LLCs.

* Tax limited partnerships which have some limited partners with limited liability and some general partners with unlimited liability as a general partnership of the general partners and a limited liability company made up of the limited partners collectively.

* Tax corporations at a flat rate equal to the highest individual income tax rate.

* Give corporations a deduction for dividends paid to shareholders (with the concept of "earnings and profits" to distinguish dividends from returns of capital retained), paid to U.S. taxpayers who are not tax exempt, for purposes of federal income taxes. For purposes of state income taxes, limit the dividends paid deduction to dividends paid to taxpayers subject to that state's income taxes.

* Tax dividends paid to U.S. taxpayers who are not tax exempt as ordinary income, eliminating the "qualified dividends" treatment of certain dividends, for purposes of federal income taxes. For purposes of state income taxes, tax dividends paid as ordinary income for taxpayers subject to that state's income taxes.

* Withhold taxes on taxable dividends paid to U.S. taxpayers (for federal income taxation purposes, and to taxpayers subject to that state's income taxes for state income tax purposes) at the highest individual income tax rate.

* Eliminate special taxes for domestic personal holding companies and the accumulated earnings tax.

* Eliminate the special deductions for income from pass through entities and for domestic manufacturing activities.

Capital Gain Taxation

* Tax capital gains as ordinary income.

* Do not allow capital losses to be applied to income other than capital gains.

Taxation Of Capital Gains At Death

* Treat assets owned by a decedent at death as if they were sold for fair market value on the date of death, subject to (1) a marital deduction, (2) the exclusion of gain on the sale of a personal residence that would have applied immediately prior to death (or half of that amount for a married decedent), (3) a limited step up in basis to fair market value at death, and (4) an ability to elect a carry over basis at death for select assets.

* Limit the step up in basis for capital gains at death to assets with a fair market value of $2,000,000 at death (without regard to the basis of those assets), applied as elected by the estate of the decedent in estate with assets that in the aggregate have a fair market value of more than $2,000,000 at death. 

* Eliminate the special step up in basis for capital gains tax purposes for community property.

* Allow a carry over basis at death election for assets to which the marital deduction does not apply for residences in which the recipient resides at the time of death, for vacant land, for farm real estate, for collectible tangible personal property like jewelry and art, for closely held business interests, and for property which cannot be liquidated at fair market value due to restraints upon alienation. The carry over basis must be disclosed on an asset by asset basis to the IRS and the recipient for each such asset for which an election is made.

Like-Kind Exchanges

* Eliminate Internal Revenue Code § 1031 like kind exchanges for real property. 

Tax Incentive Exclusions

* Eliminate (prospectively) exclusions and reductions in capital gains for qualified small business stock (IRC § 1202 stock), qualified opportunity zones, and similar provisions of the tax code.

Stock Compensation and Stock Option Compensation

* Give stock (i.e. equity interests) given in exchange for services as having a basis of zero.

* Do not make the grant or exercise of a stock option a taxable event (except to the extent that stock is sold in the transaction to pay for the stock option exercise price).

* Include all capital gains from the sale of stock received in exchange for services or through an employment compensation stock option as self-employment tax income.

* Include all dividends from stock received in exchange for services or through an employment compensation stock option as self-employment tax income.

* Include all capital gains and dividends from stock in a company in which the owner is an active participant as self-employment tax income.

* Eliminate the $1,000,000 cap on cash compensation for employees that encourages stock option compensation.

Allocation of Basis

* Require taxpayers to use average basis for fungible securities held with a firm or group of affiliated firms.

* Continue the carry over basis for gifts of appreciated assets including gifts to tax exempt entities.

Whole Life Insurance

* Tax the increase in the cash value of a life insurance policy with cash value prior to death, which is in excess of premiums paid that are in excess of term insurance premium established by regulation, as taxable income, with an exception for viatical settlements.

Gift and Estate and Generation Skipping Transfer Taxes

* Reduce the exclusion from gift and estate taxation to $2,000,000 per per, person lifetime, indexed, inheritable by a surviving spouse. Make all transfers exempt from gift and estate taxation on this basis also exempt from generation skipping transfer taxation.

* Set the estate tax rate at the maximum individual income tax rate.

* Set the gift tax rate and the generation skipping transfer tax rate at the equivalent on a tax exclusive basis to the maximum individual income tax rate on a tax inclusive basis.

* Treat split-interest trusts (charitable remainder trusts, charitable lead trusts, grantor retained interest trusts, qualified personal residence trusts, etc.) as incomplete transactions until the death of the grantor or the completion of the trust term, whichever comes first, with the gift deemed to be made and valued at that time.

* Disallow minority interest discounts (including lack of marketability discounts for a sale of less than a 100% interest in closely held entity) and ignore control premiums in gifts of entity interests.

* Disallow the annual exclusion for gifts of interests in entities, including purchases of entity interests up to the amount of an annual exclusion gift made that are made within one year of receipt of the annual exclusion gift.

* Disallow the annual exclusion for gifts to trusts with Crummy powers.

* Treat taxes paid for the benefit of an irrevocable trust (for gift and estate tax purposes) that is taxed as a grantor trust as a gift taxable gift to the trust.

Medicaid (The Poor Man's Estate Tax)

* Eliminate the Medicaid estate recovery system.

* Replace the Medicaid nursing home program income cutoff with a premium for the Medicaid nursing home program equal to income in excess of the cutoff, and double the amount of income that beneficiaries may keep.

* Increase the Medicaid asset cutoff for countable assets from $2,000 to $200,000.

* Allow gifts of up to $15,000 per beneficiary per year for Medicaid nursing home program participants without affecting eligibility.

Tax-Exempt Charities And Churches

* Tax the income of tax-exempt entities (e.g. charities and churches) from interest, dividends, capital gains, rent, royalties, and other sources of income from ownership of property at a flat rate equal to the highest individual income tax rate. In the case of payments of interest, dividends, and royalties paid by U.S. taxable limited liability entities or U.S. for profit businesses, withhold this at the source.

* End the charitable deduction for income tax purposes. Allow a deduction for advertising expenses paid to charitable entities by businesses for advertising.

* Eliminate the lobbying/political activity prohibition.

* Retain the charitable exemption for gift and estate and generation skipping transfer taxes.

* End the exemption for charities from property taxes and sales taxes.

Tax-Exempt Interest

* Eliminate the income tax exemption for all forms of municipal bonds that are currently tax exempt prospectively.

Social Security and Retirement Savings

* Make Social Security benefits tax free.

* Set the maximum income that can be considered in a defined benefit plan's benefit formula equal to the Social Security/self-employment income tax cap, which would be increased to the current defined benefit plan cap. Increase Social Security benefits to reflect this increased revenue if it can be done on an actuarially sound basis.

* Set a global cap on contributions from defined benefit plans and defined contribution plans (other than contributions in lieu of FICA taxes by governmental defined benefit plans) that can be made per year per person from all sources combined on a tax preferred basis of $10,000 per year, indexed, with defined benefit plans reporting an amount on an information return each year.

* Set a maximum dollar amount of combined defined contribution plan assets, which is reduced by a formula to take into account defined benefit plan benefits (but not below zero). If someone has defined contribution plan assets in excess that amount, the excess is a required minimum distribution in the following year. The limit would be $2,000,000 (reduced to zero at $100,000 of anticipated annual defined benefit plan benefits), indexed.

International Payments On Account Of Property

* Do not allow a deduction for payments made by U.S. taxpayers for property owned by foreign taxpayers, regardless of location, including rent, dividends, interest, and royalties on account of intellectual property.

Cash Flow Accounting For Investments and Businesses

* Eliminate deductions for depreciation, amortization and depletion (with deductions from existing transactions grandfathered).

* Allow expense deductions for capital expenditures that could previously not be expensed, but were instead deducted over time through depreciation, amortization or depletion deductions. 

* Treat the proceeds of loans incurred by for profit entities, or by individuals for business or investment purposes as taxable gross income. Allow income from loan proceeds to be carried forward one year rather than taxed in the current year at the election of the taxpayer.

* Treat principal payments on loans whose proceeds were taxable gross income as deductible.

Housing Cost Deductions

* Allow an itemized housing cost deduction up to a $36,000 per year indexed dollar cap on one or more properties owned or rented and used as a primary residence during at least three months a year by the taxpayer or a dependent of the taxpayer (this is derived from the value of the housing cost deduction for someone with a $750,000 mortgage, the largest allowed under current law, at current mortgage interest rates). Taxpayers with legacy mortgage interest that is deductible could elect to take that deduction rather than the housing cost deduction.

* The itemized deduction is available for rent, imputed income from tax free use of employer provided housing, qualified mortgage interest, mortgage insurance, HOA charges, property taxes, homeowner's insurance, renter's insurance, earthquake insurance, and flood insurance.

* Qualified mortgage interest would be limited to purchase money mortgages, mortgages used to pay for construction, renovation, or repairs, or refinancing of that debt. There would be no deduction for cash out home equity loans not reinvested in the collateral.

* Eliminate the minister's housing allowance exclusion.

Health Care Deductions

* Continue the exclusion from income for employees, and the deductibility to employers, of health insurance premiums and healthcare savings account contributions.

* Allow a deduction, above the line, without regard to income (but not reducing income below zero or subject to carry forward or carry back) for purposes of both income taxes and also for purposes of self-employment taxes, of health insurance premiums actually paid plus excess Obamacare premium credits paid to IRS on one's return, less Obamacare premium credits received on one's return.

* Allow an itemized deduction for uninsured medical expenses in excess of 2% of AGI per year.

Business Expenses

* Do not allow a business expense deduction for meals, lodging, or entertainment, unless the beneficiaries are employees or contractors who have this in kind form of compensation reported on their W-2 or 1099.

* Limit net operating loss carry forwards to three years, do not allow net operating losses to reduce income other than income from that business, and do not allow NOL carry forwards to reduce more than 50% of current taxable income from operating profits from the same business in any given year.

Special Standard Deduction

* Eliminate the special standard deduction for the elderly and the blind in order to simplify tax laws.

Simplified Earned Income Tax Credit

* Repeal the earned income tax credit.

* Add an income tax credit for everyone, never phased out, equal to 7.65% of the federal poverty line for the taxpayer (based upon filing status and number of dependents), and reflected in withholding taxes, up to a maximum of the sum of FICA taxes paid plus one-half of self-employment taxes paid. 

Reinstated Deductions

* Reinstate the casualty loss itemized deduction, without dollar/percentage limitation.

* Reinstate the cost of earning income itemized deduction, without dollar/percentage limitation, including a deduction for mandatory occupational licensing fees.

* Reinstate the state and local taxes itemized deduction for state income taxes, without dollar/percentage limitations, but disallow it for state and local property taxes (except as part of the new housing cost deduction), and disallow it for state and local sales and use taxes, and other state and local taxes.