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Tax Reform Provisions Zero in on Housing
The following are excerpts from "Simple, Fair, & Pro-Growth: Proposal to Fix America's Tax System," the final report from The President's Advisory Panel on Federal Tax Reform, that are of particular concern to the housing industry and America's home owners.
Provisions Affecting Home Ownership
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Recommendations
- Replace the deduction for mortgage interest with a Home Credit for all taxpayers equal to 15 percent of interest paid on a principal residence.
- Establish the amount of mortgage interest eligible for the Home Credit based on average regional housing costs.
- Lengthen the time a taxpayer must own and use a principal residence before gains from the sale of the home can be exempt from tax.
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The Panel recommends that the deduction for mortgage interest be replaced with a Home Credit available to all homeowners. The Home Credit would be equal to 15 percent of mortgage interest paid by a taxpayer on a loan secured by the taxpayer’s principal residence and used to acquire, construct, or substantially improve that residence. The Panel recommends that the deduction for interest on mortgages on second homes and interest on home-equity loans be eliminated.
To encourage home ownership without subsidizing overinvestment in housing, the Panel recommends limiting the amount of the Home Credit. To adjust for variations in housing markets, the Panel recommends the Home Credit limit be based on the average cost of housing within the taxpayer’s area.
The Panel considered various ways to accomplish this, and determined the limit should be based on average area home purchase prices as determined using data from the Federal Housing Administration (FHA). The IRS currently uses a similar methodology to provide average purchase price guidelines for other tax provisions. The FHA insures loans of up to 95 percent of the median home sale price in a given metropolitan area, subject to certain minimum and maximum levels. To estimate average home purchase prices, the Panel considered a mortgage interest cap that was 125 percent of the median sale price for each county (this amount is approximately 31 percent higher than the FHA amount after grossing up the FHA median values from 95 to 100 percent). This would result in current limits between approximately $227,147 and $411,704. Estimates suggest that between 85 and 90 percent of mortgages originated in 2004 would have been unaffected by the proposed Home Credit mortgage limit (using the regional limits that would have been applicable for 2004).
The Panel recognizes that limiting the amount of the current tax subsidy for mortgage interest could adversely affect individuals who purchased or refinanced homes assuming they would be able to deduct interest on up to $1.1 million of mortgage debt. To be fair to those who relied on current tax law in making important financial decisions, the options provide for a gradual phase-in of the cap over a five-year period for preexisting home mortgages. Additional information regarding the Home Credit, including the proposed transition relief can be found in the Appendix.
Under current law, up to $500,000 of capital gains on a home that a taxpayer has owned and used as his principal residence for two out of the last five years may be excluded. Although the Panel believes the exemption for gains from the sale of a principal residence should be retained for most homeowners, it also believes that the length of ownership and use required to obtain this benefit is too short. The Panel recommends that the length of time an individual must own and use a home as a principal residence to qualify for the tax exemption be increased from two out of five years to three out of five years.
Incentives for Health Insurance Coverage
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Recommendations
- Make tax benefits for health insurance fairer by allowing a deduction for the purchase of health insurance in the individual market.
- Limit the exclusion for employer-provided health coverage to the average cost of health coverage.
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The Panel recommends that employers continue to be able to deduct the cost of employee compensation, whether in the form of cash compensation or health insurance premiums, and that employees be allowed to receive a base amount of health insurance free of tax. To level the playing field between workers who have access to employer-provided health insurance plans and those who do not, the Panel recommends that workers be allowed to purchase insurance either through their employer or on their own with pretax dollars up to the average cost for health insurance. Taxpayers who, for example, do not have access to employer-provided plans would be allowed a new deduction for health premiums equal to the exclusion enjoyed by workers whose employers provide health insurance.
To ensure that the tax benefits for health insurance are distributed more evenly, however, the Panel recommends that the amount of tax-free compensation an employee could receive in the form of health insurance be limited. The exclusion for employer-provided health insurance would be limited to $11,500 for families and $5,000 for single individuals, which is the national average annual amount projected to be spent on health insurance premiums in 2006. These amounts are also roughly equal to the maximum amount of tax-free health insurance coverage provided to members of Congress and other federal employees.
Repeal the AMT
Eliminating the AMT would free millions of middle-class taxpayers – 21.6 million in 2006 and 52 million in 2015 – from filing the forms, preparing the worksheets, and making the seemingly endless calculations required to determine their AMT liability. In 2004, an individual had to fill out a 12-line worksheet to see if he needed to file Form 6251, a 55-line form with eight pages of instructions. Those eight pages of instructions also tell the individual to redo many regular tax forms and schedules, including Forms 4952 (Investment Interest Expense Deduction), 4684 (Casualties and Thefts), 4797(Sales of Business Property), and Schedule D (Capital Gains and Losses) using the AMT rules. The individual may also have to fill out and file Forms 8582 (Passive Activity Loss Limitation) and 1116 (Foreign Tax Credit) on an AMT basis. The taxpayer also has to fill out a 48-line form (Form 8801) to determine whether he is entitled to credits for prior AMT payments. Finally, the instructions warn that if the taxpayer claimed the standard deduction for regular taxes, he should recalculate his regular and AMT taxes using itemized deductions because while the standard deduction is not available under the AMT, some itemized deductions are, but only if the individual itemizes for purposes of the regular tax.
To view the panel’s full final report in PDF format, click here.
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