[Congressional Record (Bound Edition), Volume 149 (2003), Part 1]
[Extensions of Remarks]
[Pages 277-279]
[From the U.S. Government Publishing Office, www.gpo.gov]




      INDIVIDUAL AND SMALL BUSINESS TAX SIMPLIFICATION ACT OF 2003

                                 ______
                                 

                           HON. AMO HOUGHTON

                              of new york

                    in the house of representatives

                        Tuesday, January 7, 2003

  Mr. HOUGHTON. Mr. Speaker, today I am re-introducing a bill, the 
Individual and Small Business Tax Simplification Act, to address a 
problem that remains as relevant in the 108th Congress as it was in the 
107th. In 1935, there were 34 lines on Form 1040 and instructions were 
two pages. Today, the tax code and regulations have grown to over 9 
million words. According to the Tax Foundation, individual taxpayers 
spent 2.9 billion hours on federal tax compliance in 2002. This is 370 
million more hours than in 2001. Businesses spent an additional 2.75 
billion hours on tax compliance. The value of this 5.6 billion hours of 
lost time is incalculable. Our tax code is a growing thicket of 
complexity that frustrates ordinary taxpayers, is a haven for promoters 
of dubious schemes, and frequently generates unintended consequences.
  To be sure, defining income in a manner that is fair and easy to 
administer is inherently complex, but, for a variety of reasons, the 
tax code has become far more complicated than necessary. Pamela Olson, 
the Treasury Department Assistant Secretary for Tax Policy, put it well 
recently when she said that our tax system ``is surely not a tax system 
that anyone would set out to create * * * it is the system that has 
evolved over time.'' In many cases, there is a clear answer to the 
question of whether a rational person would design a tax provision the 
same way from a clean slate. The objective of the legislation I am 
introducing today is to roll back unneeded complexity for individuals 
and small business taxpayers. One or more of the bill's provisions 
would simplify annual filing for every individual taxpayer and nearly 
every business in America.
  This legislation builds on a bill that I introduced in the 106th 
Congress, the Tax Simplification and Burden Reduction Act. The Ways and 
Means Subcommittee on Oversight has held numerous hearings on tax 
simplification, and the bill draws on the record built at those 
hearings. I plan to hold additional hearings on tax simplification 
during the 108th Congress to consider ways to refine this legislation 
and to consider additional simplification proposals. Several of the 
provisions of this legislation appeared first as recommendations in the 
Joint Committee on Taxation's April, 2001 report, and the staff of the 
Joint Committee on Taxation has helped to refine the proposals 
contained in the bill. Other provisions originated with the work of the 
Tax Section of the American Bar Association and the American Institute 
of Certified Public Accountants. I have received many comments on last 
year's legislation, and I welcome comments from other individuals and 
organizations on the bill as we continue to work toward the goal of 
simplification.
  Our future as a Nation depends on our ability to raise revenue in a 
manner that is fair and equitable. The Internal Revenue Code must be 
simplified to restore faith by all taxpayers in our tax system.
  The proposal includes the following provisions:


                I. INDIVIDUAL INCOME TAX SIMPLIFICATION

  Alternative Minimum Tax--Inflation has caused many middle-income 
taxpayers to be subject to AMT by eroding the value of the AMT 
exemption. Rising state and local taxes have added to the problem, 
because state taxes are not deductible in calculating taxable income 
for AMT purposes. The failure to allow a state and local tax deduction 
for AMT purposes is one of the most unfair aspects of the Internal 
Revenue Code. It results in double taxation of income, and it forces 
taxpayers who live in states with higher income taxes to bear a larger 
percentage of the federal tax burden than those who live in states with 
lower taxes or no tax. If we allow the AMT to remain unaddressed, this 
unfair and inequitable disparity will worsen over time.
  As a result of inflation, the Joint Committee on Taxation predicts 
that more than 35 million will pay AMT within ten years. Currently, AMT 
affects less than 2 million taxpayers. A recent study by the Urban-
Brookings Tax Policy Center confirms this finding and further notes 
that if left unattended the AMT will shift a substantial portion of the 
tax burden of this country to urban and suburban middle-class 
taxpayers. Congress would not design a system with these features 
deliberately, and we should not allow it to happen by default.
  Under the proposal, the AMT exemption would be adjusted for inflation 
since the date it was enacted and indexed for inflation in future 
years. State and local taxes would become fully deductible under the 
new AMT. The effect of these changes will be to restore AMT to its 
intended purpose and stop its growth.
  Replace Head of Household Filing Status with New Exemption--Head of 
Household filing status has long been a leading source of taxpayer 
confusion and mistakes during the filing season. In 2000, the IRS 
fielded over half a million taxpayer questions on filing status. An 
error on filing status can have consequences throughout the return, and 
it can lead to costly interest and penalty charges later on. To address 
this problem, the bill replaces Head of Household filing status with a 
$3,700 ``Single Parent Exemption.'' This amount will be indexed. The 
proposal, as a whole, is revenue neutral. The bill achieves further 
simplification by cross referencing the new uniform definition of a 
qualifying child.
  Simplified Taxation of Social Security Benefits--Under present law, 
determining whether and how much social security benefits are

[[Page 278]]

subject to tax is a highly involved process that requires the 
completion of an 18 line worksheet. Many taxpayers are not eligible to 
use this worksheet, and they must refer to a 27 page publication.
  The bill would simplify the calculation by repealing the 85 percent 
inclusion rule that was enacted in 1993. This alone would remove 6 
lines from the Form 1040 worksheet. Going further, the proposal would 
index the 50 percent inclusion rule for future inflation, and greatly 
simplify the calculation of income for purposes of this rule. Tax 
exempt interest will no longer be required to be added in the 
calculation. Indexation will mean that fewer taxpayers will be required 
to complete the calculation and include benefits in income.
  Simplify Capital Gains Tax--Under present law, there are seven 
different capital gains rates that apply to various kinds of 
dispositions of property. There are special rates for taxpayers in 
lower tax brackets, for property held five years or more, and for gain 
on collectibles. Before 1986, there was one rule: 50 percent of capital 
gains are deductible. For any investor who has struggled to fill out 
Schedule D of Form 1040, it will come as welcome news that the bill 
proposes a return to the system in place prior to 1986.
  No taxpayer will pay a higher capital gains rate under this proposal. 
By definition, the capital gains rate that individuals pay will be no 
more than one-half of their marginal income tax rate. Therefore, this 
proposal preserves the progressivity that is accomplished by a rate 
structure under current law, and the maximum rate will be no more than 
one-half of the highest marginal income tax rate. Thus, the maximum 
effective capital gains rate would be 19.3 percent in 2003, and an 
individual in the 10 percent bracket would have a 5 percent capital 
gains rate.
  Repeal of 2 percent Floor on Miscellaneous Itemized Deductions--The 
bill follows the recommendation of the Joint Committee on Taxation that 
the 2 percent floor on miscellaneous itemized deductions should be 
repealed. This provision was originally enacted in 1986 to ease 
administrative burdens for the IRS and record keeping burdens for 
taxpayers.
  Instead of easing taxpayers' burdens, it has caused extensive 
litigation and controversy over such matters as whether an individual 
is properly characterized as an employee or an independent contractor. 
It has also resulted in disparate treatment of similarly situated 
taxpayers. For example, an employee whose job requires him to pay out 
of pocket for travel, professional publications, or education is 
disadvantaged compared to a taxpayer in a similar job whose employer 
reimburses such items.
  Simplify Taxation of Minor Children--This provision would eliminate 
the current restrictions on adding a minor child's income to the 
parent's return. A parent could freely elect to include the income of a 
child under 14 on his or her own tax return, regardless of the 
character and amount of the child's income. Parents and children would 
retain the ability to file separate returns, but the unearned income of 
a minor child would be subject to tax at the rates applicable to 
trusts. The single filing rate structure would continue to apply to the 
child's earned income.
  Simplify Dependent Care Tax Benefits--The bill would conform 
differences between the Dependent Care Tax Credit and the Exclusion for 
Employer-Provided Dependent Care Assistance. The two programs serve 
identical purposes, but their rules are different. Under this proposal, 
the dollar limit on the amount creditable or excludable would be 
increased to $5,500, and the percentage creditable would be increased 
to 35 percent. These provisions would be further simplified by a cross-
reference to the new uniform definition of a qualifying child.
  Accelerate Repeal of PEP and PEASE--The bill would accelerate and 
make permanent the repeal of the overall limitation on itemized 
deductions (PEASE) and the personal exemption phaseout (PEP). These 
provisions add complexity and complicate planning for millions of 
taxpayers. The Economic Growth and Tax Relief Reconciliation Act of 
2001 (EGTRRA) reduces their impact between 2006 and 2009, and they are 
repealed entirely in 2010 but, because of EGTRRA's sunset provisions, 
PEP and PEASE spring back to life in 2011.
  Uniform Definition of a Child--One of the most challenging and 
difficult problems that taxpayers face each year is to navigate the 
multiple definitions of a qualifying child for the dependent exemption, 
the child tax credit, the dependent care credit, the earned income tax 
credit, and for purposes of determining head of household filing 
status. The bill would establish a uniform definition of a child based 
on the residence, relationship, and age of the child. The proposal 
would replace the rule that requires taxpayers to prove that they 
provide more than one-half of a child's support with a preference for 
the parent who provides housing for the child for more than one-half of 
the year. In addition, the bill would establish that means-tested 
government benefits are generally disregarded in determining 
eligibility for tax benefits.
  Combine HOPE and Lifetime Learning Credits--Like the dependent care 
credit and the exclusion for employer provided dependent care 
assistance, the HOPE and Lifetime Learning Credits (LTL) serve nearly 
identical purposes, but they have different rules. The LTL credit is a 
per-taxpayer credit, and it applies on up to $10,000 of qualifying 
education expenses. The HOPE credit is a per-child credit, and it 
applies with respect to the first $2,000 of qualifying education 
expenses incurred during the first two years of post-secondary 
education. Both credits are for higher education, but taxpayers face a 
challenge to determine which credit is best for their circumstances. 
The bill would merge the two credits, providing a credit for one-half 
of the first $3,000 of post-secondary education expenses. This credit 
would apply on a per-child basis, and it would not be limited to the 
first two years of post-secondary education.
  Uniform Definition of Qualifying Higher Education Expense--The bill 
adopts the recommendation of the Joint Committee on Taxation that there 
should be a uniform definition of higher education expense for purposes 
of the various education tax benefit programs. The varying definitions 
that exist in current law greatly complicate the task of determining 
which education benefit is best for the taxpayer.


                 II. small business tax simplification

  Uniform Passthrough Entity Regime--This provision would combine the 
benefits of Subchapter S (S corporations) and Subchapter K 
(Partnerships) of the Internal Revenue Code in a single, unified 
passthrough entity regime based on Subchapter K. While at one time, 
Subchapter S provided the only avenue for prospective investors to 
avoid the corporate-level tax while retaining a full liability 
protection, the emergence and broad acceptance of limited liability 
companies (LLCs) has provided investors with an alternative. There are 
now two separate, fully articulated passthrough entity regimes.
  Maintaining two separate passthrough entity regimes is expensive and 
unnecessarily complicated. It increases costs both for taxpayers and 
for the IRS. At a time when the IRS is striving to train its auditors 
to understand passthrough entities, and a new class of investors is 
struggling to understand the pros and cons of the two regimes, the time 
is ripe to rationalize this most complex area of the Internal Revenue 
Code by reconciling Subchapter S and Subchapter K.
  The objective of the proposal is to establish a single passthrough 
entity regime that preserves the major benefits of Subchapter S and 
Subchapter K. Domestic corporations that are not publicly traded would 
have a new election to be treated as a partnership for federal tax 
purposes, and the S election would be repealed. The proposal would 
therefore endorse, and extend, the 1996 Check-the-Box regulations to 
allow state law corporations to elect partnership status. Existing S 
corporations would be permitted to continue as S corporations for ten 
years at which time they would be required to elect partnership or 
corporate status.
  So as not to undermine the corporate tax that will remain applicable 
to publicly traded corporations and other entities that elect to be 
taxed as corporations, a corporation that elects partnership status 
with undistributed earnings and profits will be required to track 
distributions of earnings under rules similar to IRC Section 1368. 
Similarly, electing corporations (including S corporations) with 
appreciated assets will be required to pay a built in gains tax if they 
sell or dispose of such assets within the first ten years after the 
election. The net proceeds of built in gain transactions will be added 
to historic earnings and profits and not currently taxed to the 
partners. Finally, the election to be taxed as a partnership will not 
itself be treated as a sale or disposition of assets.
  Consistent with the overall objective of preserving the benefits of 
Subchapter S, the proposal will establish a means for passthrough 
entities to engage in tax free reorganizations with entities classified 
as corporations. Under the proposal, a partnership engaged in an active 
trade or business may contribute substantially all of its assets to a 
new corporation and immediately thereafter engage in a tax free 
reorganization.
  The bill would also adopt a recommendation of the American Institute 
of Certified Public Accountants and the American Bar Association that 
the definition of earnings from self-employment should not include the 
portion of

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a partner's distributive share that is attributable to capital. This 
proposal contains reasonable safe harbors and it would eliminate the 
disparate treatment of limited partners, S corporation shareholders, 
and limited liability company members. The current rules can only be 
described as a historical anachronism and a significant trap for the 
unwary. Additionally, the bill would adopt the recommendation of the 
Joint Committee on Taxation that the electing large partnership rules 
should be eliminated.
  Some may argue that by repealing the S election, the proposal forces 
more taxpayers to contend with a more complex tax regime, but this is 
generally not true. If there is a demand, investors can create an 
investment vehicle with all the features of an S corporation by 
contract or they may select a state law business form that restricts 
flexibility, such as a corporation or close corporation. This would 
eliminate nearly all of Subchapter K's feared complexity. The relative 
complexity of Subchapter K stems from its greater flexibility. The 
proposal allows investors to regulate the level of tax complexity by 
voluntary agreement among the investors or through the investors' 
choice of a state law business entity.
  Increase Section 179 Expensing Limit--The bill would increase the 
limit on expensing to $25,000 in the tax year after enactment and to 
$40,000 after 2012. This measure will greatly reduce complexity for 
many small businesses by minimizing controversy over whether an item 
should be expensed or capitalized.
  Rollover of Property Held for Productive Use or Investment--Present 
law strongly favors sophisticated taxpayers over ordinary small 
business owners in the execution of like-kind exchange transactions. 
Thirty-seven pages of the Code of Federal Regulations is devoted to the 
topic of like-kind exchanges, and a library could be filled with the 
court decisions, revenue rulings, and letter rulings that Section 1031 
of the IRC has engendered. Attorneys and exchange facilitators must 
execute hundreds of thousands of pages of documents each year to comply 
with the formalistic rule that prevents the owners of like-kind 
property from receiving cash in a like-kind exchange transaction.
  There is a simple way to eliminate this paperwork: repeal the 
limitation on sales for cash and allow a like-kind exchange within 180 
days before or after the disposition of relinquished property. The bill 
does this.
  Repeal of Collapsible Corporation Rules and the Personal Holding 
Company Tax--Finally, the bill would repeal the collapsible corporation 
rules and the Personal Holding Company tax, both of which regimes have 
been largely eclipsed by subsequent changes to the tax code. The 
Collapsible Corporation rules have lost their rationale, due to the 
repeal of the General Utilities doctrine. The Personal Holding Company 
tax no longer serves its original purpose, because the maximum 
individual income tax rate is close to the maximum corporate rate. Both 
provisions continue to add complexity to small business tax planning 
that is out of proportion to their remaining tax policy justification. 
Repeal of these rules is long overdue.
  I urge my colleagues to join me in cosponsoring this legislation.

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