PHASE-OUTS BASED ON INCOME LEVEL

 

 Present Law

 

Numerous sections in the tax law provide for the phase-out of benefits from certain deductions or credits over various ranges of income based on various measures of the taxpayer’s income. There is currently no consistency among these phase-outs in either the measure of income, the range of income over which the phase-outs apply, or the method of applying the phase-out. Furthermore, the ranges for a particular phase-out often differ depending on filing status, but even these differences are not consistent. For example, the IRA deduction phases out over a different range of income for single filers than it does for married-joint filers; whereas the $25,000 allowance for passive losses from rental activities for active participants phases out over the same range of income for both single and married-joint filers. Consequently, these phase-outs cause inordinate complexity, particularly for taxpayers attempting to prepare their tax returns by hand; and the instructions for applying the phase-outs are of relatively little help. See the attached Exhibit for a listing of most current phase-outs, including their respective income measurements, phase-out ranges and phase-out methods.

 

Recommended Change

 

True simplicity could easily be accomplished by eliminating phase-outs altogether and adjusting the tax rates. However, if that is considered either unfair (simplicity is often at odds with equity) or politically impossible, significant simplification can be achieved by creating consistency in the measure of income, the range of phase-out (including as between filing statuses) and the method of phase-out.

 

Instead of the at least 14 different phase-out ranges (shown in attached Exhibit A), there should only be three -- at levels representing low, middle, and high income taxpayers.

 

All phase-out ranges for married-filing-separate (MFS) taxpayers would be 50 percent of the range for married-filing-joint (MDJ), and the phase-out ranges for single and head of household (HOH) taxpayers would be 75 percent of married-joint.

 

The benefits that are specifically targeted to low-income taxpayers, such as the earned income credit, elderly credit, and dependent care credit, would phase-out under the low-income taxpayer phase-out range. The benefits that are targeted not to exceed middle income levels, such as the IRA deduction, would phase-out under the middle-income taxpayer phase-out range. Likewise, those benefits that are targeted not to exceed high income levels, such as the AMT exemption, itemized deductions, personal exemptions, adoption credit and exclusion, series EE bond exclusion, and section 469 $25,000 rental exclusion and credit, would phase-out under the high-income taxpayer phase-out range. See the chart below.

 

Additionally, instead of the differing methods of phase-outs (shown in attached Exhibit B), the phase-out methodology for all phase-outs would be the same, such that the benefit phases out evenly over the phase-out range. Every phase-out should be based on adjusted gross income (AGI).

 

Proposed Income Level Range for Beginning to End of Phase-Out for Each Filing Status

Category of Taxpayer Married Filing Joint Single & HOH MFS

LOW-INCOME $ 10,000-$ 25,000 $ 7,500-$ 18,750 $ 5,000-$ 12,500

MIDDLE- INCOME $ 40,000-$ 50,000 $ 30,000-$ 37,500 $ 20,000-$ 25,000

HIGH-INCOME $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

 

EXHIBIT A - Selected AGI Phase-out Amounts

 

IRC Section Provision Ftnt. Current-Joint Current-Single & HOH Current -Married/Sep. Proposed -Joint Proposed-Single&HOH Proposed - Married/Sep.

PHASE-OUT LEVELS FOR LOW-INCOME TAXPAYERS

21 30 Percent Dependent Care Credit (3) $10,000-$20,000 $10,000-$20,000 no credit $10,000-$25,000 $7,500-$18,750 $5,000-$12,500

22 Elderly Credit (4) $10,000-$25,000 $7,500-$17,500 $5,000-$12,500 $10,000-$25,000 $7,500-$18,750 $5,000-$12,500

32 EITC (No Child) (2,3, 4) $5,000-$9,230 $9,230 no credit $10,000-$25,000 $7,500-$18,750 $5,000-$12,500

32 EITC(1 Child) (2,3, 4) $5,000-$24,396 $5,000-$24,396 no credit $10,000-$25,000 $7,500-$18,750 $5,000-$12,500

32 EITC (2 or MoreChildren) (2,3, 4) $11,000-$26,673 $11,000-$26,673 no credit $10,000-$25,000 $7,500-$18,750 $5,000-$12,500

PHASE-OUT LEVELS FOR MIDDLE-INCOME TAXPAYERS

219 IRA Deduction (1) $40,000-$50,000 $25,000-$35,000 $0-$10,000 $40,000-$50,000 $30,000-$37,500 $20,000-$25,000

PHASE-OUT LEVELS FOR HIGH-INCOME TAXPAYERS

135 EE Bond int. Exclusion (1, 2) $74,200-$104,200- $49,450-$64,450 no exclusion $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

23 & 137 Adoption Credit/Exclusion (1) $75,000-$115,000 $75,000-$115,000 no benefit $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

55 AMT Exemption (1) $150,000-$330,000 $112,500-$247,500 $75,000-$165,000 $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

68 Itemized Deduction level (2) $117,950 $117,950 $58,975 $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

151 Personal Exemption (2) $176,950-$299,450 $117,950-$240,450 HOH$147,450 -$269,950 $88,475-$149,725 $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

469(i) $25,000 Rental (1) $100,000-$150,000 $100,000-$150,000 $50,000-$75,000 $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

469(i) Credit (1) $200,000-$250,000 $200,000-$250,000 $100,000-$125,000 $150,000-$300,000 $112,500-$225,000 $75,000-$150,000

 

NOTE: There are legislative proposals with even more phase out levels (e.g., family tax credit, education tax credit/deduction.)

 

Footnotes: (1) Modifications to AGI; (2) Inflation indexed; (3) Earned income limitations; (4) Low income only

EXHIBIT B - Current Method of Phase-Out

 

Section(s)

21 - credit percent reduced from 30 percent to 20 percent in AGI range noted by 1 percent credit for each $2,000 in income

22 - credit amount reduced by ½ of excess over AGI range

23 & 137- benefit reduced by excess of modified AGI over lower amount noted divided by 40,000

32 - credit determined by earned income and AGI levels

55 - exemption reduced by 1/4 of AGI in excess of low amount noted

68 - itemized deductions reduced by 3 percent of excess AGI over amount noted

86 - up to 50 percent/85 percent of social security benefit taxed to extent modified AGI reaches levels noted

135 - excess of modified AGI over lower amount divided by 15,000 (single), 30,000 (joint) reduces excludable amount

151 - AGI in excess of lower amount, divided by 2,500, rounded to nearest whole number, multiplied by 2, equals the percentage reduction in the exemption amounts

219 - Individual retirement account (IRA) limitation ($2,000/$2,250 for 1996; $2,000/$4,000 for 1997) reduced by excess of AGI over lowest amount noted divided by $10,000

469(i) - benefit reduced by 50 percent of AGI over low amount noted

 

Contribution to Simplification

 

The current law phase-outs complicate tax returns immensely. The instructions are impossible to understand and the computations cannot be done by the average taxpayer by hand. The differences among the various phase-out income levels are tremendous. Either we should eliminate phase-outs and accomplish the same goal with a lot less complexity by adjusting rates, or at least make the phase-outs applicable at consistent income levels (only 3) and ranges and use a consistent methodology. This would ease the compliance burden on many individuals. If there were only three ranges to know and only one methodology, it would be a lot simpler and easier to recognize when a phase-out should apply. Many portions of numerous Internal Revenue Code sections could be eliminated.