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By the end of September a bipartisan nine-member panel is set to release a comprehensive plan to dramatically change the federal tax system. The panel has been holding public hearings to consider testimony on potential changes. At present, several scenarios are under consideration. Here are some possible proposals and the impact they might have on taxpayers and other parties. Even after the panel releases its final recommendations for change, it may be a long time, if at all, before the proposals are enacted. Simplify Current System No one disputes that the present income tax rules are unnecessarily complex, but ways to simplify them depend on where you stand. Some people will lose while others gain from simplification. For example, if the multitude of retirement plan options � such as profit-sharing plans, 401(k) plans, SIMPLE plans (The SIMPLE-IRA Plan was designed to make it easier for small businesses to offer a tax-advantaged, company-sponsored retirement plan. The SIMPLE plan is a flexible, easy to administer retirement plan for businesses with 100 or fewer employees. SIMPLE plans are funded by employer contributions and can be funded by elective employee salary deferrals.) and Simplified Employee Pension Plan, commonly known as a SEP-IRAs � are reduced to a single retirement savings vehicle, it is uncertain whether small businesses would continue to offer company-sponsored plans since owners could fund their own savings plan without having to pay for employees. This would leave those workers to provide for their own retirement. Also, certain financial institutions, such as insurance companies, may lose a market for some products, such as variable annuities. Other items that may be under consideration for simplification include the various education incentives currently available. Presently, there are 529 tuition plans and Coverdell education savings accounts to save for education costs, as well as tax credits and deductions to pay for higher education costs on a tax-advantaged basis. Simplification would mean reliance on a single tax incentive for education purposes. Elimination of any tax break can be expected to be fought by groups affected by the change. Several years ago, for example, there had been a suggestion to repeal the deduction for home mortgage interest but this was highly unpopular politically because of the vast number of homeowners. Complete Overhaul Another possible approach would be to shift the focus of the current income tax system from a tax on income to a tax on consumption as a way to encourage more U.S. savings. In order to put money aside today, you must first pay income tax on earnings. Often this means a double tax � for example, a tax on corporate earnings and a tax on shareholders’ dividends from those earnings (because the corporation cannot deduct the dividends it pays out). The income tax would generally be limited to a tax on wages and a tax on corporate capital income (without a deduction for interest payments on corporate borrowing), with only very limited deductions allowed. Other types of income would not be taxed. Adopt a VAT Tax A third approach would be to impose a national sales tax in much the same way as the European value-added tax (VAT). The tax would be imposed on goods and services and could raise enough revenue to replace or at least significantly simplify the current income tax system. For example, it has been suggested that most of the current deductions would be eliminated and a flat income tax rate could be something like 25 percent or less. A VAT-type tax has been under consideration without success since the 1970s. If it were adopted, it would mean an immediate jump in the price of goods, but only consumers would be affected. In effect, those who are savers rather than spenders would come out ahead. States generally oppose the concept of a VAT-type tax. Having a federal sales tax would make it more difficult for states to raise their sales tax rates when they need revenue. Also, some legal scholars suggest that a national sales tax may be unconstitutional. AMT Repeal A parallel discussion on what to do with the basic current tax system involves proposals for the alternative minimum tax (AMT). This alternative tax system was designed to ensure that all taxpayers paid at least some income tax even though deductions and credits helped them greatly reduce or eliminate their regular tax. Currently, about 3.8 million individuals pay the AMT. It is projected that in 2006, the number could reach 20.5 million. The reason: Higher exemption amounts that keep many individuals from owing an AMT now are set to expire at the end of 2005. Without any changes in the system, as many as 51.3 million taxpayers, which is 45 percent of all taxpayers, could owe an AMT by 2015. The President’s Advisory Panel on Federal Tax Reform has recognized that the AMT as it now stands is complex, unfair and ineffective in achieving its objective that all taxpayers pay some tax (The Alternative Minimum Tax Staff Presentation, July 20, 2005). The panel favors a complete repeal of the current AMT. Scrapping the AMT entirely, however, is problematic in view of the substantial revenue that the tax raises � $15 billion in 2004 and, by estimations, $210 billion by 2015. To follow developments on these and other tax proposals, go to www.taxreformpanel.gov . Other Proposals Parallel to the efforts on reforming the overall tax system, a number of tax bills affecting the current system are making their way through Congress. These include: � National Employee Savings and Trust Equity Guarantee Act of 2005, which would change a number of rules affecting qualified retirement plans and IRAs designed to give workers a more secure retirement (Joint Committee on Taxation Report, JCX-56-05, at www.house.gov/jct ). � Tax Technical Corrections Act of 2005, which would make many needed clarifications and corrections to prior legislation, including a number of rules on the new domestic production activities deduction (Joint Committee on Taxation Report, JCX 55-05, at www.house.gov/jct ). � Energy Policy Act of 2005 (H.R. 6), which includes tax incentives for energy-efficient technologies, including tax credits for certain residential improvements. Sidney Kess, CPA-attorney, is a consulting editor to CCH Inc., an author and a lecturer.

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