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Under prior law, section 164(a) provided (in the last sentence of that subsection) that, in addition to the four types of State, local, and foreign taxes (enumerated in that section) for which itemized deductions were allowed, other State, local, and foreign taxes were deductible if paid or accrued in the taxable year in carrying on a trade or business or an investment-type activity described in section 212. However, a specific provision of the Code (for example, sec. 189 or sec. 263) might require capitalization of certain otherwise deductible taxes.
Reasons for Change
The Congress concluded that, as part of the approach of the Act in reducing tax rates through base-broadening, it is appropriate to disallow the itemized deduction for State and local sales taxes. In addition, a number of other considerations supported repeal of this deduction.
Prior law did not permit itemized deductions for various types of State and local sales taxes, such as selective sales taxes on telephone and other utility services, admissions, and sales of alcoholic beverages, tobacco, and gasoline. Also, prior law did not allow consumers any deduction to reflect inclusion, in the selling price of a product, of taxes levied at the wholesale or manufacturer's level. Accordingly, the Congress concluded that extending nondeductibility to all State and local sales taxes improves the consistency of Federal tax policy, by not providing an income tax benefit for any type of consumption subject to sales taxes. Further, to the extent that sales taxes are costs of purchasing consumer products or other items representing voluntary purchases, allowing the deduction was unfair because it favored taxpayers with particular consumption patterns, and was inconsistent with the general rule that costs of personal consumption by individuals are nondeductible.
The Congress did not find persuasive evidence for arguments that eliminating the sales tax deduction could provide unwarranted encouragement for States to shift away from these taxes and could be unfair to States that retain them. On the contrary, it is significant how small a portion of general sales taxes paid by individuals actually were claimed as itemized deductions. Data from 1984 show that less than one-quarter of all such sales taxes levied were claimed as itemized deductions; by contrast, well over one-half of State and local income taxes paid by individuals are claimed as itemized deductions. The Congress believed that the fact that the large majority of sales tax payments were not claimed as itemized deductions under prior law alleviates any effect of repealing the deduction on the regional distribution of Federal income tax burdens or on the willingness of State and local governments to use general sales taxes as revenue sources.
For itemizers who did not rely on the IRS-published tables to estimate their deductible sales taxes, the prior-law deduction for sales taxes involved substantial recordkeeping and computational burdens, since the taxpayer had to determine which sales taxes
were deductible, keep receipts or invoices showing the exact tax paid on each purchase, and calculate the total of all deductible sales taxes paid. Also, allowing State and local sales taxes to be deducted had created legal controversies between taxpayers and the IRS regarding what was a general, as opposed to a specific, sales tax. Thus, repealing the deduction advanced the goal of simplifying the tax system for individuals.
For itemizers who did rely on the IRS tables, the amount of deductions that could be claimed under prior law without challenge from the IRS could vary significantly in particular instances from the amount of general sales taxes actually paid to State and local governments. The tables did not provide accurate estimates for individuals who had either lower or higher levels of consumption than the average, and did not reflect the fact that an individual might purchase items in several States having different general sales tax rates. Accordingly, use of the tables neither accurately measured the amount of disposable income an individual retained after paying general sales taxes, nor accurately provided an appropriate Federal tax benefit to residents of States that impose general sales taxes.
The Congress concluded that the tax treatment of sales and other taxes incurred in a business or investment activity (but not expressly enumerated as deductible under sec. 164) should be consistent with the tax treatment of other costs of capital assets. Thus, for example, the amount of sales tax paid by a business on acquisition of depreciable property for use in the business is treated under the Act as part of the cost of the acquired property for depreciation
Explanation of Provisions
The Act repeals the prior-law itemized deduction for State and local sales taxes under section 164.
The Act adds a limitation to the effect of the provision (under prior law, set forth as the last sentence of sec. 164(a)) with respect to deductibility of State and local, or foreign, taxes incurred in a trade or business or in a section 212 activity. This new limitation does not affect ded city of the six types of taxes listed in the first sentence of exstion 16an (1) State and local, and foreign, real property taxes, (2, State and vocal personal property taxes; (3) State and local, and fore me, war profits, and excess profits taxes; (4) the windfail profit tax. 46), (5) the environmental tax (sec. 59A); and (6) tre exipping transfer tax imposed on income distributions. The suctibility or capitalization of these enumerated casqua t'u may be modified by provisions in Title VIII of the Art,
Under the A., & arma, oral, or foreign tax (other than one of the enumerat Tura, or accrued in carrying on a trade or business or a witch. Liburity is paid or accrued by the tax
payer in connection with the acquisition or disposition of property, the tax shall be treated, respectively, as a part of the cost of the acquired property or as a reduction in the amount realized on the disposition. This limitation does not apply to such a tax if not incurred by a taxpayer in connection with the acquisition or disposition of property; e.g., sales taxes on restaurant meals that are paid by the taxpayer as part of a deductible business meal are deductible (subject to the business meal reduction rule described in I.E., below).
The provisions are effective for taxable years beginning after December 31, 1986.
The provisions are estimated to increase fiscal year budget receipts by $968 million in 1987, $5,197 million in 1988, $4,708 million in 1989, $4,907 million in 1990, and $5,131 million in 1991.
2. Increased floor for itemized deduction for medical expenses (sec. 133 of the Act and sec. 213 of the Code)28
Individuals who itemize deductions may deduct amounts paid during the taxable year (if not reimbursed by insurance or otherwise) for medical care of the taxpayer and of the taxpayer's spouse and dependents, to the extent that the total of such expenses exceeds a floor (sec. 213). Under prior law, the floor was five percent of the taxpayer's adjusted gross income.
Medical care expenses eligible for the deduction are amounts paid by the taxpayer for (1) health insurance (including employee contributions to employer health plans); (2) diagnosis, cure, mitigation, treatment, or prevention of disease or for the purpose of affecting any structure or function of the body; (3) transportation primarily for and essential to medical care; and (4) lodging while away from home primarily for and essential to medical care, subject to certain limitations. The cost of medicine or a drug qualifies as a medical care expense only if it is a prescription drug or is insulin. Capital expenditures
Treasury regulations provide that the total cost of an unreimbursed capital expenditure may be deductible in the year of acquisition as a medical expense if its primary purpose is the medical care of the taxpayer, the taxpayer's spouse, or the taxpayer's dependent (Reg. sec. 1.213-1(e)(1)(iii)). Qualified capital expenditures may include eyeglasses or contact lenses, hearing aids, motorized chairs, crutches, and artificial teeth and limbs. The cost of a mova
28 For legislative background of the provision, see: H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 134; S.Rep. 99-313, pp. 57-60; Senate floor amendment, 132 Cong. Rec. S 7665-73 (June 17, 1986); and H.Rep. 99-841, Vol. II (September 18, 1986), pp. 2122 (Conference Report).
ble air conditioner may qualify if purchased for the use of a sick person.
In addition, the regulations provide that the cost of a permanent improvement to property that ordinarily would not have a medical purpose (such as central air conditioning or an elevator) may be deductible as a medical expense if the expenditure is directly related to prescribed medical care, but only for any portion of the cost that exceeds the increased value of the property attributable to the improvement. Related operating and maintenance costs also may be deducted provided that the medical reason for the capital expendi
ture continues to exist.
Under these rules, the Internal Revenue Service has treated as medical expenses the cost of hand controls and other special equipment installed in a car to permit its use by a physically handicapped individual, including a mechanical device to lift the individual into the car (Rev. Rul. 66-80, 1966-1 C.B. 57). Also, the IRS has ruled that the additional costs of designing an automobile to accommodate wheelchair passengers constitute medical expenses, including the costs of adding ramps for entry and exit, rear doors that open wide, floor locks to hold the wheelchairs in place, and a raised roof giving the required headroom (Rev. Rul. 70-606, 1970-2 C.B. 66). Similarly, specialized equipment used with a telephone by an individual with a hearing disability has been held deductible as a medical expense, since the equipment was acquired primarily to mitigate the taxpayer's condition of deafness (Rev. Rul. 71-48, 19711 C.B. 99).
The IRS also has ruled that capital expenditures to accommodate a residence to a handicapped individual may be deductible as medical expenses (Rev. Rul. 70-395, 1970-2 C.B. 65). In that ruling, the taxpayer was handicapped with arthritis and a severe heart condition; as a result, he could not climb stairs or get into or out of a bathtub. On the advice of his doctor, he had bathroom plumbing fixtures, including a shower stall, installed on the first floor of a two-story house he rented. The lessor (an unrelated party) did not assume any of the costs of acquiring or installing the special plumbing fixtures and did not reduce the rent; the entire costs were paid by the taxpayer. The IRS concluded that the primary purpose of the acquisition and installment of the plumbing fixtures was for medical care, and hence that such expenses were deductible as medical expenses.
Floor under deduction
Reasons for Change
The Congress concluded that, as part of the approach of the Act in reducing tax rates through base-broadening, it was appropriate to increase the floor under the itemized deduction for medical expenses. A floor under this deduction has long been imposed in recognition that medical expenses essentially are personal expenses and thus, like food, clothing, and other expenditures of living and other consumption expenditures, generally should not be deductible in measuring taxable income.
In raising the deduction floor to 7.5 percent of the taxpayer's adjusted gross income, the Act retains the benefit of deductibility
where an individual incurs extraordinary medical expenses-for example, as a result of major surgery, severe chronic disease, or catastrophic illness-that are not reimbursed through health insurance or Medicare. Thus, the Act continues deductibility if the unreimbursed expenses for a year are so great that they absorb a substantial portion of the taxpayer's income and hence substantially affect the taxpayer's ability to pay taxes. The Congress also believed that the higher floor, by reducing the number of returns claiming the deduction, will alleviate complexity associated with the deduction, including substantiation and audit verification problems and numerous definitional issues.
The Congress also concluded that it is desirable to clarify that certain capital expenditures incurred to accommodate a personal residence to the needs of a handicapped taxpayer, such as construction of entrance ramps or widening of doorways to allow use of wheelchairs, qualify as medical expenses eligible for the deduction. The Congress believed that this clarification was consistent with Federal policies that seek to enable handicapped individuals to live independently and productively in their homes and communities, thereby avoiding unnecessary institutionalization.
Floor under deduction
Explanation of Provision
The Act increases the floor under the itemized medical expense deduction from five to 7.5 percent of the taxpayer's adjusted gross income.
The Congress clarified that capital expenditures eligible for the medical expense deduction include certain expenses of removing structural barriers in the taxpayer's personal residence for the purpose of accommodating a physical handicap of the taxpayer (or the taxpayer's spouse or dependent). These costs are expenses paid by the taxpayer during the year, if not compensated for by insurance or otherwise, for (1) constructing entrance or exit ramps to the residence; (2) widening doorways at entrances or exits to the residence; (3) widening or otherwise modifying hallways and interior doorways to accommodate wheelchairs; (4) installing railings, support bars, or other modifications to bathrooms to accommodate handicapped individuals; (5) lowering of or other modifications to kitchen cabinets and equipment to accommodate access by handicapped individuals; and (6) adjustment of electrical outlets and fixtures. (The enumeration of these specific types of expenditures is not intended to preclude the Treasury Department from identifying in regulations or rulings similar expenditures for accommodating personal residences for physically handicapped individuals that would be eligible for deductibility as medical expenses.)
The Congress believed that the six categories of expenditures listed above do not add to the fair market value of a personal residence and hence intended that such expenditures are to count in