No matter who wins the upcoming election....

The Kiplinger Tax Letter

Circulated Biweekly to business clients since 1925

1100 13th Street NW, Washington, DC 20005 Kiplinger.com Vol. 87, No. 21

Dear Client,

Washington, Oct. 12, 2012

No matter who wins the upcoming election...

 Itemized deductions will be in the crosshairs.  Although the two candidates have very different views on how to overhaul the current income tax system, they both think itemized deductions should be curbed.

President Obama wouldn't kill itemizations, so the deductions for mortgage interest, donations to charity, and state and local taxes would be retained. But he'd nick these write-offs in two ways

         

First, Obama would reinstate a 3% cutback in itemized deductions that lapsed after 2009, but at higher income levels than before.  Deductions other than medical expenses, investment interest paid or casualty losses would be trimmed by 3% of the amount by which AGI exceeds $250,000 for MFJ, $225,000 for HH, $200,000 for Singles and $125,000 for MFS.  The reduction could not exceed 80% of itemized deductions.

  

Second, he'd reduce the value of itemized deductions for high-incomers...write-offs that remain after applying the 3% reduction that we just detailed for you.  

  

The tax value of itemizations would be capped at 28% beginning in 2013.  When coupled with his proposal to reinstate the 36% and 39.6% brackets, taxpayers in brackets above 28% would be paying an extra tax of up to 11.6% of their write-offs.

  

But the president's proposal would hit more than just itemized deductions:

  

Interest on municipals and employer health coverage would be partly taxed for filers above the 28% bracket.  The interest and the value of coverage would be taxed at up to 11.6%.  Also nailed: Tax breaks for domestic production, student loan interest, college tuition, self-employeds' health insurance, IRA payins and 401(k) contributions.

  

Mitt Romney takes a different tack.  He'd put a cap on itemized deductions, although he has not provided a detailed proposal yet.  Recently, he has mentioned that filers could be limited to $17,000 of itemized deductions, although he's also said the ceiling could end up at $25,000 or even $50,000.  It's not clear whether the ceiling would be the same for singles and married.  He's also state that he'd keep write-offs such as mortgage interest and donations to charities.  But whatever the final number, if your total Schedule A deductions exceeded the cap, you would get no tax benefit for the excess itemizations, even if they consisted of mortgage interest or donations.

  

The exact deduction limit depends on the fate of Romney's tax reform plan.  He is proposing to slash marginal tax rates for individuals by 20% across the board.  Tax rates currently range from 10% to 35%.  Under Romney, they'd be 8% to 28%.  That would produce a tax cut for those folks who don't itemize.  Romney has stated that he wants tax reform to be revenue neutral.  And he has said that his tax plan won't reduce taxes paid by the wealthy.  Therefore, the higher the cap is on deductions, the more pressure there will be to reduce the size of the tax cuts for high-incomers.  So upper-incomers with very large itemized deductions may wind up net losers.

Health Care

          An employer’s religious objections to the health care law are overruled by a federal district court.  A for-profit company whose owner is Catholic and operated the firm consistent with his religious beliefs challenged the requirement that health plans subject to the law mst provide no-cost coverage for contraception.  But the court dismissed the suit (O’brien v. Health and Human Services, D.C., Mo.).  In Aug., we reported on a similar lawsuit in which the private employer prevailed.  The case is on appeal.  The Supreme Court will probably have the final say.

Payroll Taxes

          More on refund claims for FICA tax on severance pay for laid-off workers: Claims should be filed sooner rather than later.  Last month, the Sixth Circuit ruled that severance payments made to involuntarily laid-off workers are exempt from FICA tax.  Because many companies withheld payroll taxes on these payments, large refunds will be due if the Supreme Court upholds the Sixth Circuit’s decision.  That will catch the eye of revenue hungry taxwriters, who may very well decide to legislatively overrule the decision.  Any congressional action is likely to be done on a prospective basis, so refund claims filed before Congress acts should be OK.  Claims should be filed on Form 941-X, not Form 843 as we indicated last month.  Firms whose protective refund claims were denied should use Form 907 to ask the Service to agree to stop the running of the two-year limitation period for filing a lawsuit in federal court for a refund.  IRS usually Oks these requests.

To be continued…