Beware and be weary of proposal

Posted on Wed, Oct. 19, 2005

Tax-code overhaul could hit state hard
BUT RECOMMENDATIONS STILL HAVE LONG WAY BEFORE BECOMING LAW
By Jim Puzzanghera and Mark Schwanhausser, Mercury News

WASHINGTON - Trying to make the federal tax code fairer, President
Bush's tax reform panel Tuesday approved recommendations that have many
middle-income Californians crying foul: slashing coveted deductions
such as mortgage interest, state and local tax payments and health
insurance premiums.
Silicon Valley's homeowners would be among the hardest hit, losing
thousands of dollars in tax breaks on the area's high-priced homes.
Homeowners now can write off interest on up to $1.1 million in mortgage
and home equity debt. Under the bipartisan panel's plan, that deduction
would be limited to interest on the first $312,895 borrowed, less than
half the cost of the $705,000 median-price home in Santa Clara County
in September.
Real estate and tax experts fear such changes would chill California's
housing market, making it harder for buyers to stretch into their first
home or trade up.
``That might be the deal-breaker here,'' said Sharon Kreider, a
Sunnyvale certified public accountant. ``Or house prices have to go
down to accommodate that.''
The tax panel's recommendations are part of a plan to dramatically
simplify the federal tax code, turning an array of complex tax breaks
into a small set of easy-to-calculate credits that would allow most
people to file a one-page return every April 15.
But the proposals of the president's Advisory Panel on Federal Tax
Reform are a long way from law.
Mid-term elections
The group, which has been studying the tax code since January, must
submit its final report by Nov. 1 to Treasury Secretary John Snow, who
will review it and make his recommendations to the White House. Bush,
who in January said tax reform was his second-highest priority behind
overhauling Social Security, will consider the proposals and make
recommendations to Congress. Congress isn't likely to address the
proposals until next year while facing mid-term elections, when there
is traditionally little appetite for controversial legislation.
And the panel's proposals already are stirring things up. Politicians
in states with high taxes and housing prices, such as California and
New York, were sharply critical Tuesday.
``This proposal does not simply affect a small portion of wealthy
homeowners; it would impact nearly the entire state, and worse, those
who are living paycheck to paycheck may be forced to sell their
homes,'' Sen. Dianne Feinstein, D-Calif., said in a written statement.
She noted that a family purchasing a median-price home in the state
would lose $6,727 a year in tax deductions. ``I support tax reform, but
it should not be on the backs of Californians.''
One in three Californians filing federal income taxes takes a mortgage
interest deduction, and eliminating the deductibility of state and
local taxes would cost 5.9 million Californians an average of more than
$2,200 a year, said State Treasurer Phil Angelides, another Democrat
who blasted the plan.
H.D. Palmer, a spokesman for the state Department of Finance, said Gov.
Arnold Schwarzenegger's administration will analyze the report's final
recommendations to determine the impact on California.
The nine-member, federal tax reform panel, including two Californians,
predicted most taxpayers would see little change in their overall
payments. The group said the changes would be offset by decreasing
overall tax rates, eliminating taxes on U.S. stock dividends and
increasing the capital gains exemption for the sale of a primary home
-- from $500,000 for a couple today to $600,000, with annual
adjustments for inflation.
The foundation of the panel's recommendations is to abolish the
alternative minimum tax, a tax originally intended for the rich that
increasingly is snagging middle-income Americans. The AMT does not
allow deductions for state and local taxes, so the panel argues more
and more taxpayers will lose the deduction anyway.
Repealing the AMT will cost the government at least $1.2 trillion in
revenue over the decade, so Bush instructed the panel to find
offsetting tax increases.
``This has not been an easy job,'' said former Sen. John Breaux, D-La.,
the panel's co-chair. ``So how do we pay for it? We made some tough
recommendations.''
Among the recommendations that also could impact Californians is
limiting the tax break for health insurance to $11,500 for families and
$5,000 for individuals. The proposed changes would make the federal tax
code fairer, said Elizabeth Garrett, a University of Southern
California professor serving on the panel.
Defining `modest'
She said the plan would allow a new ``home credit'' of up to 15 percent
of mortgage interest to homeowners who don't itemize their federal
returns and currently cannot deduct those costs. The cap on mortgage
interest would be linked to Federal Housing Administration mortgage
limits set county-by-county each year.
They are based on the cost of a ``modest home'' she said, and range
from $172,632 in low-cost states such as Idaho and Arkansas to $312,895
for most of California.
But there's nothing modest about home prices in Silicon Valley. Take
the case of a middle-income buyer who makes a 10 percent down payment
and takes out a 6 percent loan on a median-price $705,000 home in Santa
Clara County.
Currently, a taxpayer in the 25 percent income tax bracket can deduct
nearly $9,500 in mortgage interest. The panel would cleave the maximum
deduction to less than $4,700. The proposed 15 percent credit would
slash the tax write-off to $2,800 -- costing the homeowner an extra
$555 a month.
``I bet it would stop some people in their shoes if they were expecting
to put not much down payment into it,'' said Claudia Hill, owner of Tax
Mam Tax Services Group in Cupertino. ``It would make fewer buyers
qualify for the high end, and when it comes to the middle market it
would make buyers think twice about how they would finance it.''
The panel discussed phasing in the change over five years to ease the
hit on existing borrowers, but that means homeowners probably would
lose more than half their current write-off in three years. And the
protection would be eliminated altogether if homeowners refinanced -- a
tactic many borrowers plan to use before payments on interest-only
loans and other exotic mortgages vault higher.
``Imagine that, you'd be locked into a higher interest rate or a bad
loan because you'd lose your tax deduction if you refinanced,'' said
Kreider, the accountant. ``We'd be figuring out whether we should pay
more to the bank on this bad loan or pay more in taxes to the IRS.''

Contact Jim Puzzanghera at .com or (202)
383-6043. Contact Mark Schwanhausser at news.com
or (408) 920-5543.