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Is Your Mortgage Interest Deduction At Risk?

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Is your mortgage interest deduction at risk?

What about your charitable donation deduction? Your real estate tax deduction? Your medical expenses deduction?

Under a new conservative plan introduced by Sen. Pat Toomey (R-PA), one of the members of the "Super Committee", the amounts that taxpayers could claim as deduction on a Schedule A would be limited. In exchange, tax rates would drop in every income tax bracket.

The details are still being fleshed out but it would appear that the most dramatic cuts would start at the top, with tax rates dropping from 35% to 28%, to make up for the initial loss in deductions. Cuts would follow through all of the brackets with the bottom tax rate slated to be 8% (yes, still less than Warren Buffett).

Tax breaks from itemized deductions would not be eliminated but they would be limited, likely as a percentage of adjusted gross income. It's also been suggested that the amount of employer-provided health insurance excluded from taxable income would be limited as a percentage of income; the latter is clearly meant to head off plans to tax health care benefits in the future.

So you're waiting for the righteous indignation from me, right? Here's the thing: I think this plan is smart. Flawless? Of course not. But it shows some promise.

For years, most tax pundits, myself included, have chirped about how expensive itemized deductions are in terms of lost revenue. But, most taxpayers, and again, myself included, don't really want to give them up. But realistically, the scale of itemized deductions benefit a limited number of taxpayers at a fairly steep cost in terms of lost revenue. In addition, itemized deductions can be complicated and time consuming to figure and substantiate, costing taxpayers in terms of return prep and increased risk of examination.

It makes sense that the less appealing it is to itemize, the more likely taxpayers will claim the standard deduction. And despite the sense at tax time that everyone itemizes, most taxpayers do not: the overwhelming majority of taxpayers opt for the standard deduction. Only about a third of taxpayers choose to itemize.

Eliminating extra breaks and flattening rates is astonishingly simple. And - this should make some folks happy - it creeps a bit closer to the idea of a flat tax. (I said closer, not there. You know I'm not a fan.)

So does it have a chance?

Not as proposed. There's a lot going on.

For one, you can bet that before you're finished reading this piece, lobbyists for the real estate industry will be furiously making calls and plotting strategies to block it. Despite the fact that taxpayers don't actually "save" money by spending more on a home, the home mortgage interest deduction is often incorrectly framed as the only reason that the real estate market stays afloat. And while a haircut limitation on interest deductions will not affect most taxpayers or significantly shake up the market, you can bet that the hullaballoo that follows will make you think that it's the end of the world.

Charities don't like limitations either because of the potential to dissuade high dollar donors. Statistically, more donations per capita are made by taxpayers who do not itemize (think those of you who drop coins in the Salvation Army bucket or some dollars in the offering plate) but on a dollar for dollar basis, charities tend to receive the largest support from big donors.

More importantly, Democrats are not fans of the plan, claiming that it disproportionately benefits those at the top. While it's true that the proposal would include the biggest cuts at the top, the thinking is that the limit on the deductions for those taxpayers should result in equitable results. That's yet to be seen.

Efforts to make this partisan fight are confusing since President Obama proposed a similar strategy in 2009 for taxpayers at the top (with some exceptions, the same taxpayers that are most affected by this plan). Obama was soundly criticized by Republicans at the time who failed to take note that the plan was not all that different from the tax structure under President Reagan.

That doesn't mean that the Republicans have resounding support from within their own party for the proposal. While House Speaker John Boehner (R-OH) indicated that he might be on board with the idea, Republican majority leader Eric Cantor (R-VA) hasn't been so supportive.

For now, the idea is a work in progress. The "Super Committee" has six days to make it something more. Do you think they'll get there?

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