THINK ONLY THE RICH guys get all the tax breaks? Wrong, deduction denier! In fact, most of the big tax breaks go to middle income earners like you and me. We do not call them tax shelters, but that really is what they are. The pros call these shelters "tax expenditures." These deductions and credits have the same impact on the Federal budget as direct expenditures. That's because they represent dollars not collected by the government. Each of these expenditures gives special or selective tax relief only to certain targeted groups. Sounds like a tax shelter, or at least a loophole, to me.
These targeted provisions either encourage some desired activity or provide special aid to certain taxpayers. Some of them make a lot of sense. For example, the Federal government seeks to encourage certain forms of investment. So, Congress legislates accelerated, rather than straight line, depreciation. This produces more tax savings up front, creating additional capital for business to expand. Tax advantaged investment helps create new businesses and new jobs. These new jobs produce more paychecks and those additional paychecks produce more taxes. In the long ran, if everything works as it should, everyone wins.
Some tax expenditures have been adopted as relief provisions to ease hardships or simplify tax computations. For instance, the elderly and the blind receive special benefits through a deduction called the "additional amount," which is added to their standard deduction. Other tax benefits for the aged--the retirement income credit and the potential exclusion of Social Security payments from taxable income--also fall into this personal or hardship category.
In 1980, the Congressional Budget Office had 92 provisions that qualified as tax expenditures, at a cost of $206,000,000,000. Pres. George W. Bush's fiscal year 2004 budget called for individual tax expenditures projected at more than $800,000,000,000. The financial benefits offered resemble those available on the spending side of the budget. A tax expenditure provision can provide relief in any of the following ways:
* Special exclusions, exemptions, and deductions, which reduce taxable income and result in a smaller tax liability--for example, tax exempt municipal bond interest or the exclusion from taxable income of employee discounts or dependent care assistance programs.
* Preferential rates, which reduce liabilities by applying lower rates to all or part of your income--for instance, the special reduced maximum tax rate on long term capital gains or on qualified dividends.
* Special credits, which are subtracted from your tax liability, rather than from the income on which your taxes are figured--for example, the child tax credit or the foreign tax credit.
* Deferrals of tax, which allow you to pay later rather than now. Such deferrals really constitute an interest-free loan from the IRS for instance, …