Federal Income Tax Reform and the Potential Effects on Farm Households

By Durst, Ron; Williamson, James | Amber Waves, February 2013 | Go to article overview

Federal Income Tax Reform and the Potential Effects on Farm Households


Durst, Ron, Williamson, James, Amber Waves


Highlights:

* The complexity of the current tax code, together with perceptions that it distorts economically efficient decisions and is inequitable, has led to calls for fundamental tax refo rm.

* Efforts to broaden the tax base by removing special tax provisions enacted to encourage or give preference to specific economic activities could have a significant impact on taxpayers who currently benefit fro m those provisions, including many farm households.

* Proposals to subject capital gains and dividends to ordinary income tax rates and to reduce the ability of business owners to shelter income from taxation could affect a large number of farm households, especially those operating larger farms.

The Federal tax code has long been used further various economic and social policy objectives. While special tax provisions have resulted in reduced income tax liabilities for many taxpayers, they have added complexity and raised questions regarding the efficiency and fairness of the current income tax code. This increased awareness has raised interest in comprehensive tax reform. Several proposals-including a report by the co-chairs of the National Commission on Fiscal Responsibility, a bipartisan panel created to address the fiscal stability of the United States-call for fundamental reform of the Federal income tax system. The primary elements common to many reform proposals-eliminating tax preferences (exclusions, deductions, and credits), restructuring capital gains and dividend tax rates, lowering marginal tax rates, and reducing the number of tax brackets-could have a significant impact on the aftertax income and well-being of farm households.

The Primary Objectives of Tax Reform

The impetus to reform the income tax system is the desire to make the tax system simpler to administer and comply with, more efficient, and more equitable. Proponents of reform argue that the current system with its multitude of tax preferences is needlessly complicated, distorts economic decisions, and is unfair. They call for "broadening the tax base," a term used to describe treating more income as taxable by eliminating special tax provisions. While the specifics of the various reform proposals vary, most share two common elements-lower marginal income tax rates and reduced income exclusions, deductions, and credits (provisions that effectively narrow the tax base or shield income from tax). These base broadening changes include:

* Capping various income exclusions such as those for health insurance and retirement, two of the largest and most widely used tax preferences.

* Reducing or eliminating various itemized deductions, including the deductions for mortgage interest, charitable contributions, and State and local taxes.

* Restructuring income tax credits, including the earned income and child tax credits that provide significant benefits to lowincome taxpayers.

* Eliminating the preferential tax rate on capital gains and dividends, the benefits most of which are concentrated among high-income taxpayers.

Comprehensive individual income tax reform that involves many of these tax preferences would affect nearly all taxpayers, including farmers. For many, the lower marginal tax rates would offset the loss of various tax preferences, resulting in little change or even lower income tax liability. However, consistent with the goal of a fairer tax code, those farmers and other taxpayers receiving the greatest benefit from the current income tax structure could face higher taxes under comprehensive reform.

Most Federal Income Tax for Farm Households Is on Off-Farm Income

The individual income tax system is more important than the corporate income tax for understanding how tax reform will affect most farmers. Sole proprietorships, partnerships, and subchapter S corporations are all taxed at the individual level. Since these business organizations account for more than 96 percent of U. …

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