Lessons for Tax Planners

Article excerpt

ARRA Shows How Congress Is Changing Taxes for Individuals

Calculating one's tax liability for purposes of Form 1040 is a static process that focuses on existing rules. In contrast, tax planning is a more comprehensive endeavor, aimed at minimizing tax liability in both current and future years. Conceptually, the goals of tax planning are to reduce taxable income or reduce the effective tax rate. Effective tax planning includes a dynamic element that considers tax policy trends.

Following the adage that we best know the future if we know the past, this article examines the American Recovery and Reinvestment Act of 2009 (ARRA), with an eye to identifying noteworthy changes in how Congress determines the tax liability for individual taxpayers. Since practically all of the tax legislation emanating from the first session of the 111th Congress is found in ARRA, it serves as an excellent predictor of what types of tax legislation might be forthcoming. A close look at ARRA's income tax provisions reveals three trends that are relevant to Form 1040 tax planning:

* Expenditures are becoming increasingly important as a basis for tax liability.

* Temporary tax provisions are becoming more common.

* Tax credits are being used more frequently than deductions or exclusions.

2009 Tax Legislation

In stark contrast to its subsequent lengthy impasse on healthcare reform, the newly elected 111th Congress began 2009 with a seldom-witnessed bipartisan sense of urgency. Three days following Barack Obama's inauguration as president, Representative David Obey (D-WI) introduced HR. 1, a major taxing and spending bill. Less than one month later, ARRA was signed by President Obama and became Public Law 111-5.

Later in the year, Public Law 111-92 was enacted. It too contains tax legislation. Its provisions, however, are limited to updating or expanding items contained in ARRA - the first-time home buyer's credit and the five-year net operating loss carryback Accordingly, ARRA provides a comprehensive picture of the manner in which the 11 lth Congress deals with tax matters.

ARRA begins with a multitude of economic stimulus measures. Division B of the act addresses tax matters. According to a count by tax students at New York University Law School, it contains more than 300 changes to the Internal Revenue Code. As evidenced by Exhibit I, many of the income tax provisions of ARRA are intended to provide tax relief for individuals, address global warming concerns, and assist small businesses.

A closer examination of P.L. 111-5 reveals three more subtle, but potentially important, trends in federal tax policy: 1) the emerging importance of de facto taxing of expenditures (or consumption) rather than income, 2) the increasing tendency of Congress to enact temporary tax laws, and 3) an expansion of the use of tax credits versus tax income deductions or exclusions.

What follows is an analysis of ARRA' s sections that are most applicable to determining how individuals are taxed. Exhibit 2 provides a breakdown of the trends, with each of the 39 sections categorized as either 1) expenditure- or income-focused, 2) temporary (two years or less) or permanent, and 3) tax credit- or deduction-focused. While the categories assigned to the sections are by and large objective, interpretation is necessary in some instances.

Expanded Use of Expenditures as a Basis for Tax Liability

Congress's inclination to use expenditures or consumption most clearly evidences itself in P.L. 11 1-5' s "Energy Incentives" provisions. There is no explicit tax on energy use. Instead, it relies almost exclusively on tax preferences - primarily tax credits - that are awarded to individuals and entities that take steps to consume less energy.

In contrast, ARRA's 'Tax Incentives for Businesses" provisions (Subtitle C) reflect the more traditional method of using income as the primary determinant of tax liability. …