Taxes in the Twilight Zone

twilight-zone-spiralI love watching Twilight Zone episodes because it is fun to imagine a world where the usual laws of nature are slightly askew and anything becomes possible.  Fanciful minds can do a lot with that.  Yet, some of those episodes are a bit creepy, even scary and sometimes disturbing.

Congress’ failure to act timely to provide any kind of certainty about tax law both for 2012 and for future years has definitely defied the usual laws which govern rational behavior.  Clearly Republican lawmakers would rather tax the poor and middle class than allow taxes to become progressive again on the top 1%, and it is quite clear that they wish to further the shameful increase in wealth and income inequality in the U.S.

Thanks to this failure, we have wandered across the obscure boundaries of normal reality into twilight zone of taxation.  Here is an overview of our current creepy, scary, and disturbing tax system:

Creepy

  • The zero percent tax rate for millionaires.  How is it possible that millionaires could pay no tax even though they have taxable income?  The zero percent rate was carefully crafted by Bush-era policy makers to permit this by allowing ordinary deductions to first offset ordinary income.  If ordinary deductions, such as charitable contributions, mortgage interest, state income taxes and investment management fees offset an investor’s interest income in full, that investor can be in a position to pay zero percent on all capital gain and dividend income up to the bottom of the 15% bracket.  This is up to $70,700 per year (Married Filing Joint) that is being taxed at zero percent.  The rest of us will pay tax on all of our capital gain and dividend income, because we are working for a living, and can’t possibly manipulate our tax bracket to get below the 15% level.  For investors, this is easy to control, through timing of capital gains, and through investment choices such as the use of municipal bonds or non-dividend paying stocks. And, how many working poor do you know that have an investment portfolio?  Creepier still:  Obama’s tax proposal will not impact this bizarre anomaly – the only hope for this provision to die is for us to fall off the fiscal cliff and keep diving.

Scary

  • The Alternative Minimum Tax affecting some 33 million taxpayers this year, compared to 4 million last year.  Thanks to Congress’ failure to enact the annual “AMT patch” – something it has been doing for decades – means that the AMT exemption amount will revert back to its non-inflation-indexed amount.  This is because the original law failed to index the exemption for inflation.  Rather than fix this permanently, Congress continuously “patches” the exemption amount each year by indexing it to inflation for that year only.  This is because actually fixing the AMT would be far too rational, and remember, we are in the Twilight Zone.  So, millions of taxpayers will see dramatic increases in their tax bills for 2012, and it will especially hit those with incomes between $100,000 and $200,000, with an average increase of about $3,000.  Not only that, failure to patch the AMT has caused IRS to delay being able to finalize its tax forms for 2012.  The latest news from the IRS Commissioner is that one hundred million taxpayers will not be able to file their returns until sometime in March of 2013.

Disturbing

  •  Unfair income matching rules which target low income taxpayers, while failing to tax the bulk of the underground economy.  I have always found it interesting that Congress and the IRS have gone to great lengths to make sure that baby sitters, housekeepers, and child care providers report their income and pay their taxes.  Yet, construction contractors are not subject to 1099 requirements when payments to them are non-business related, such as when they are remodeling your house.  In order to claim a child care credit or compensate your nanny, IRS makes sure that everything gets reported on a W-2 or is otherwise matched to the worker’s tax return.  Also, they are hell-bent on making sure that restaurant servers report their tips.  Why don’t we have these same kinds of requirements for plumbers, builders, and construction contractors.  Ever wonder about how construction workers can be paid “under the table?”  It might be because the contractors themselves are not reporting their income, so paying someone under the table becomes a piece of cake.  Most industry observers are well aware of this kind of outrageous noncompliance, but nothing has been proposed to tax what is probably a huge portion of the underground economy.  I’m not just picking on contractors, though.  A legitimate tax system is one in which all income is taxed, not just the income of the poor and working class.
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