The Coming Year: Social Security Top Tax Issue

Congress has a heap of tax issues on its plate, but don't expect any action until President Clinton's impeachment trial winds up.

"No one knows if it's going to be short, long, congenial or ugly," says Ron Aucutt, an estate planning tax attorney and partner at McGuire Woods Battle & Boothe in Washington, D.C. In any case, "it will definitely tie up the Senate."

Once the impeachment mess is resolved, Congress probably will turn first to Social Security, the issue du jour. I talked to a number of tax lawyers and tax-policy directors from the major accounting firms, and some believe Congress will not go forward with anything else until the Social Security system is placed on firmer financial footing.

Republican leaders said this week they would like to see tax cuts of up to $500 billion over the next ten years. If and when they and their Democratic counterparts get past the Social Security issue, the list of "must-haves" in a 1999 tax bill looks a lot like last year's: eliminating the "marriage penalty," creating a long-term care credit, updating the alternative minimum tax and reducing estate taxes.

Social Security

The government's Social Security trust fund is forecast to run out of money around 2012, drained by retiring baby boomers, according to a February 1997 report from the House-Senate Joint Economic Committee.

The Clinton administration wants to bail out Social Security using a budget surplus that is expected to be around $80 billion in 1999 and grow to approximately $251 billion by 2008, according to an August 1998 Congressional Budget Office report.

Other alternatives for making Social Security solvent include raising the retirement age and raising the payroll or FICA tax. But politicians floated these proposals in the past only to see them shot down. So don't count on them.

Other proposals would allow Social Security funds to be invested in the equity markets. Currently, Social Security funds are invested in government Treasury bills, yielding around 4.4% annually.

"You can expect to see part of the Social Security system privatized before year-end," predicts Bill Arnone, national director of employment financial education services at Ernst & Young. "It's the proverbial camel's nose under the tent," he says.

If some of the money does go into the equity markets, should individuals have the right to decide how to invest these funds? Are they educated enough to do that? Or should government money managers handle the investing?

Lack of investor education is a concern, and measures would have to be put in place to discourage investment fraud, says Roger Lorence, director of tax research at American Express Tax and Business Services.

There are a several proposals circulating through the halls of Congress, each suggesting a different amount of money an individual can control. And most still will guarantee a minimum benefit amount, even if an investment in the stock market proves disastrous.

Medicare

Saving Medicare is a close second to bailing out Social Security on the Clinton administration's list of priorities. "It'll be bankrupt before Social Security," asserts Tom Ochsenschlager, tax partner at Grant Thornton in Washington, D.C. That could occur as soon as 2002, according to a February 1997 CBO report.

It is very unlikely both issues will be entirely resolved in the next 12 months, "unless they ship some Congressmen off to a private location and demand that they don't come out until the problem is solved," says Ochsenschlager. There won't be major headway this year, but you can anticipate the creation of task forces and guidelines, he says.

'Marriage Penalty'

Currently, a dual-income married couple pays more in taxes than if each spouse filed as a single taxpayer. This "marriage penalty" is "on the top of the conservative hit parade," says Clint Stretch, director of tax policy at Deloitte & Touche in Washington, D.C. House Ways and Means Committee Chairman Bill Archer (R, Texas) pushed unsuccessfully in 1998 to eliminate the penalty. You can expect it to be reintroduced in 1999, says Lorence.

Unfortunately there is no simple way to do it, says Ochsenschlager. There is talk about creating a married tax rate table that better mimics the single rates. But that's "going to cost enormous amounts of money," says Ochsenschlager. And those rates wouldn't be fair for the family that has a nonworking spouse. So don't expect total relief, even though both parties will pay lip service to it, he says. In the end, perhaps there will be some kind of small credit -- not an across-the-board rate reduction.

Long-Term Care Credit

On Monday -- apparently from out of nowhere -- President Clinton proposed a $1,000 long-term health-care credit to compensate taxpayers struggling to provide care for elderly or disabled family members.

The President had discussed this issue before and has finally found the money to implement it. "So he is going to push this," says Stretch. "Especially because he needs a lasting legacy," adds Arnone. With Social Security reform up in the air, some lasting reform on health care, which is high on his list of important issues, could be just what the doctor ordered.

It is very likely this credit will pass, especially because there's support from both parties behind it. As a matter of fact, Senate Finance Committee Chairman William Roth (R, Del.) thinks the credit is too small and is pushing to enlarge it, says Ochsenschlager.

Alternative Minimum Tax

The alternative minimum tax, or AMT, surely will come up this year, says Stretch.

Because the current tax law allows for many deductions and credits, the alternative minimum tax system was introduced to make sure that everyone at least pays some tax. (See this for more on AMT.) But AMT is not adjusted for inflation. So more taxpayers than originally intended are becoming eligible to pay AMT.

"They have either to get rid of it or substantially cut it back," says Stretch. You can expect to hear solutions proposed throughout the year.

Estate Tax

Only 1% of taxpayers actually pays estate tax, and it only raises $20 billion in revenues annually, says Martin Nissenbaum, national director of personal income tax planning at Ernst & Young. But it doesn't take a genius to figure out why this is an important issue to influential constituents. So legislators will try to address this issue in the 1999 tax bill. Be prepared to hear continual talk of dissolving the whole estate tax system. But don't count on that happening this year.

One strong likelihood is that the Uniform Estate and Gift Tax Credit will be accelerated, says Lorence. In 1999, the limit is $650,000 -- that's how much you can give away over your lifetime tax-free. The limit is set to gradually increase to $1 million by 2006. Rep. Archer would like to see the $1 million credit take effect in 1999.

Acceleration of Benefits

Also high on the Republican wish list is to accelerate benefits that were enacted in the Small Business Act of 1996, says Ochsenschlager.

• Currently, small businesses are allowed to expense up to $19,000 of capital assets in 1999. Look for that figure to be increased to $25,000 this year. (It is currently scheduled to rise to $25,000 in 2003.)

• Congress will try to simplify pension plan rules for small business as well, notes Nissenbaum. Currently the rules are too complicated for a mom-and-pop shop to do set a plan up without professional help.

• Self-employed individuals get only a 45% health-care deduction, rising gradually to 100% by 2007. Congress will push to accelerate the schedule. It's only fair. Employers get a 100% deduction now for their employees' health insurance.

Interest and Dividend Policy

In the interest of tax simplification, there is a proposal to allow a married couple to exclude up to $400 of interest and dividends ($200 for an individual) from taxes. This is a revival of an old rule, which allowed $200 in dividends to be excluded, says Aucutt. Expect to hear about this. "It's close to top of their list," says Stretch.

Also in '99

Expect to hear more noise on reducing capital gains tax rates, increasing Roth IRA adjusted gross income limitations and more flat-tax proposals. But don't expect any action in 1999. There are bigger issues on the table this year.

There's talk of increasing the annual Education IRA contribution amount from a measly $500 to at least $2,000. It would be a meaningful gesture but don't hold your breath.

You'll hear more from the Internal Revenue Service promoting electronic filing. The new goal is have 80% of taxpayers e-filing by 2005, instead of 2007, as we previously reported.

If you have a home office, don't forget that the qualifying rules for taking a home office deduction have eased for 1999. Click here for the details.

Liberalized rules for dealing with innocent spouses, enacted in December, are now in effect. That means the IRS will be more understanding of those unwitting individuals who become responsible for their spouses' financial shenanigans

One thing not on Congress' agenda: More guidance for you day traders out there. At least not this year.