Simplification of phase-outs: unnecessary complexity.

The AICPA has long advocated simplification. In fact, in April 1997, the AICPA submitted over 50 simplification proposals to the National Commission on Restructuring the Internal Revenue Service (with copies sent to members of Congress and Treasury and their staffs). One such simplification proposal would eliminate the many complicated phase-outs in the tax law (see Exhibits I and II on pages 726 and 727) and adjust the tax rates or, if that is not possible or considered unfair, would at least create consistency in the Measure of income, and in the range (including between filing statuses) and method of all phase-outs. Unfortunately, Congress did not listen to us and, in the Taxpayer Relief Act of 1997, enacted in August 1997, added at least five new additional phase-out ranges to the already complex phase-outs in the Code (see the items citing footnote 6 in Exhibit II). Many of these phase-outs will affect the average taxpayer, who will have to consider them in order to claim the new education loan interest deduction, the new child credit, the new Hope and lifetime learning credits, and the new individual retirement account (IRA) rules.

[EXHIBIT I AND II NOT REPRODUCIBLE IN ASCII]

The proposal and exhibits (below) were developed by a working group of the Tax Division's Individual Taxation Committee, composed of Doug McCulley, Working Group Chair; Abram Serotta; and Ron Hegt; with Ward Bukofsky, Individual Taxation Committee Chair; and Eileen Sherr, Individual Taxation Committee Technical Manager.

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 phaseouts in either the measure of income, the range of income over which the phase-outs apply or the method of applying the phaseouts. Further, while the ranges for a particular phase-out often differ depending on filing status, even these differences are not consistent. For example, the traditional IRA deduction phases out over a different range of income for single filers than it does for married joint filers, while 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, needless complexity, particularly for taxpayers attempting to prepare their tax returns by hand; the instructions for applying the phase-outs are of relatively little help. (Exhibits I and II list the 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 and adjusting the tax rates. However, if that is considered either unfair or politically impossible, significant simplification can still be achieved.

Instead of the at least 20 different phaseout ranges, there should be only three--at levels representing low-, middle- and high-income taxpayers.

All phase-out ranges for married filing separate (MFS) taxpayers would be 50% of the range for married--filing jointly (MFJ), and the phase-out ranges for single and head of household (HOH) taxpayers would be 75% of married-joint. (If there are revenue concerns, the ranges and percentages could be adjusted, as long as the phaseouts for each income level group stayed consistent across all relevant provisions.)

Benefits 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. Benefits targeted not to exceed middle-income levels (such as the traditional IRA deduction and education loan interest expense deduction) would phase out under the middle-income taxpayer phase-out range. Likewise, those benefits targeted not to exceed high-income levels (such as the new child care credit, new education credits and IRAs, and the new Roth IRA, as well as the existing alternative minimum tax exemption, itemized deductions, personal exemptions, adoption credit and exclusion, Series EE bond exclusion, and Sec. 469 $25,000 rental exclusion and credit) would phase out under the high-income taxpayer phase-out range.

Additionally, instead of the differing methods of phase-outs (shown in Exhibit 1), the phase-out methodology for all phaseouts would be the same, such that the benefit phases out evenly over the phaseout range. Every phaseout should be based on adjusted gross income (AGI).

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 hand by the average taxpayer. The differences among the various phase-out income levels are tremendous. Either legislators should eliminate the phaseouts and accomplish the same goal with a lot less complexity by adjusting rates, or at least make the phaseouts applicable at consistent income levels (only three) and apply them to consistent ranges and use a consistent methodology. This would ease the compliance burden on many individuals. With only three ranges and one methodology to consider, determining whether and how a phase-out applies would be much simpler.

From Eileen Sherr, CPA, Technical Manager, AICPA Tax Division, Washington, D.C.; Ward M. Bukofsky, CPA, Braverman, Codron & Co., Beverly Hills, Cal.; Ronald Hegt, CPA, Hays & Company, New York, N.Y.; Douglas B. McCulley, CPA, Phoenix, Ariz.; Abram Serotta, CPA, Serotta, Maddocks, Evans & Co., Augusta, Ga. Mr. Bukofsky chairs the Tax DIVISION'S INDIVIDUAL Taxation Committee and is a member of the Committee's simplification Wirking Group. Mr. Hegt, Mr. McCulley and Mr. Serotta are members of the Committee and the Working Group.