3. Individual Income Tax Provisions a. Credit for child and dependent care expenses Present Law Present law provides a tax credit equal to up to 30 percent of certain employment-related child and dependent care expenses. For example, expenses of a day care center or home infant care are eligible for the credit if incurred to enable the taxpayer to work. The amount of such expenses eligible for the credit is limited to $2,400 ($4,800 for the care of two or more individuals). The 30-percent credit rate is reduced by one percentage point for each $2,000 (or portion thereof) of adjusted gross income (AGI) between $10,000 and $28,000. The credit rate is 20 percent for individuals with AGI exceeding $28,000. Possible Proposals 1. The credit rate could be reduced by one percentage point for each $2,000 (or portion thereof) by which AGI exceeds $50,000. Under this proposal, no credit would be allowed to taxpayers with AGI exceeding $88,000. 2. Expenses of overnight camps could be made ineligible for the credit. Pros and Cons Arguments for the proposals 1. Under present law, the child care credit may be claimed by high-income individuals who do not need Federal tax subsidies for their child care expenses. 2. In many cases, high-income individuals claim a credit for expenses that would be incurred regardless of whether both spouses are working outside the home, e.g., nursery school, housekeeper, and summer camp costs. 3. In the case of a parent's expenditures to send a child to an overnight camp (such as a summer camp in a vacation area), the personal element of the expenditure predominates over any income-producing connection. Accordingly, tax subsidies should not be given for the costs of sending a child away from home to camp merely because the child's parent or parents work outside the home. Arguments against the proposals 1. To the extent that child care expenses incurred to enable the taxpayer to work represent expenses of earning income, the tax treatment of such expenses should be the same for all eligible taxpayers regardless of income level. 2. Middle-income two-earner couples lost various deductions as a result of the 1986 Act, such as the two-earner deduction and IRAs. To disallow the child care credit in addition would be perceived as unfair. 3. There is no reason to allow the credit for costs of a child's attending a day camp while not in school but to deny it merely because the child attends an overnight camp, since both types of expenditures enable the child's parent or parents to work outside the home. b. Interest expense deduction on home equity loans Present Law Under present law, as amended by the 1986 Act, the itemized deduction for personal interest is being phased out over the period 1987-1990. Personal interest is any interest, other than interest incurred or continued in connection with the conduct of a trade or business (other than the trade or business of performing services as an employee), investment interest, or interest taken into account in computing the taxpayer's income or loss from passive activities for the year. These rules are phased-in and become fully effective in 1991. Present law provides that qualified residence interest is not subject to the limitation on personal interest. Qualified residence interest is interest on debt secured by a security interest valid against a subsequent purchaser on the taxpayer's principal residence or a second residence of the taxpayer. Interest on such debt is generally deductible to the extent that the debt does not exceed the amount of the taxpayer's basis for the residence (including the cost of home improvements). Present law also allows a taxpayer to deduct as qualified residence interest the interest on certain loans incurred for educational or medical expenses up to the fair market value of the residence. A grandfather rule treats interest on debt incurred on or before August 16, 1986 and secured by the taxpayer's principal or second residence as qualified residence interest, provided the amount of the debt does not exceed the fair market value of the residence. Thus, under present law, a taxpayer may deduct interest on a loan secured by a lien on his or her residence, up to the amount of the original cost of the residence (plus improvements), even though the loan proceeds are used for personal purposes. These loans are being advertised by lending institutions as "home equity loans”. In computing an individual's alternative minimum tax under present law, personal interest is deductible only if that interest is on a loan which was incurred in acquiring, constructing, or substantially rehabilitating a taxpayer's residence. Thus, interest on "home equity loans" not used for such purposes is not deductible in computing the minimum tax. Possible Proposals 1. The rule currently applicable under the minimum tax limiting the deduction for interest on a qualified residence loan to interest incurred in connection with a loan to acquire, construct, or rehabilitate a taxpayer's principal or second residence could be adopted for purposes of the regular tax. 2. The interest deduction for home equity loans for noneducational, nonmedical purposes could be limited to $10,000 per year. 3. Interest on home equity loans without a fixed term could be made nondeductible. 4. The amount of debt eligible for the qualified residence exception could be limited to $1 million. 5. It could be clarified that boats and mobile homes are ineligible to qualify as second residences for purposes of the interest expense deduction. Pros and Cons Arguments for the proposals 1. The proposals would tend to limit the interest deductions to situations where the incentive would directly encourage home ownership. 2. Present law discriminates against persons who have no equity in their homes against which to borrow when personal indebtedness is incurred. These proposals would treat all taxpayers more nearly equally with respect to these personal loans. 3. The proposals would carry out the intention of Congress to prevent deduction of interest on debt used to acquire consumer goods which do not give rise to taxable income. 4. Present law encourages persons to give lenders a lien on their residence for consumer debt, which could cause loss of the residence in the case of nonpayment of the loan. These proposals would take away that encouragement. Arguments against the proposals 1. The proposals might encourage homeowners to make low down payments and arrange loans with small or no principal payments in order to maximize interest deductions. There is no sound public policy reason for encouraging taxpayers to do so. 2. The proposals would encourage individuals to borrow more than they really need to purchase a house in anticipation of future needs for funds. 3. The proposals could make borrowing for educational and medical purposes more costly. 4. The proposals may be contrary to the policy of allowing some level of deductibility of personal interest in the case of homeown ers. |