Question

Explain and critically analyze the tax treatment of the following tax expenditures:

​​1. Realized capital gains

​​2. Unrealized capital gains

​​3. Home mortgage interest deductions

​​4. Employer contributions to health insurance plans and 401k programs

Answer 1

1. Realized Capital gains- Capital gains are profits from the sale of a capital asset, such as shares of stock, a business, a parcel of land, or a work of art. Capital gains are generally included in taxable income, but in most cases, are taxed at a lower rate. A capital gain is realized when a capital asset is sold or exchanged at a price higher than its basis. Basis is an asset’s purchase price, plus commissions and the cost of improvements less depreciation. Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Short-term capital gains are taxed as ordinary income at rates up to 37 percent; long-term gains are taxed at lower rates, up to 20 percent. Taxpayers with modified adjusted gross income above certain amounts are subject to an additional 3.8 percent net investment income tax (NIIT) on long- and short-term capital gains.

2. Unrealized Capital gains- An unrealized gain, by contrast, is simply a gain on paper. If the value of one of your investments goes up but you don't actually sell it, it won't impact the taxes.

3. Home mortgage interest deductions- Under 26 U.S.C.163(h) of the Internal Revenue Code, the United States allows a home mortgage interest deduction, with several limitations. First, the taxpayer must elect to itemize deductions, and the total itemized deductions must exceed the standard deduction (otherwise, itemization would not reduce tax). Second, the deduction is limited to interest on debts secured by a principal residence or a second home. Third, interest is deductible on only the first $1 million of debt used for acquiring, constructing, or substantially improving the residence, ($500,000 if filing separately) or the first $100,000 of home equity debt regardless of the purpose or use of the loan. Taxpayers are allowed an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. Economists have demonstrated that high-cost high-income areas receive most of the tax benefit

4. Employer contributions to health insurance plans and 401k programs- Employer contributions are deductible on the employer’s federal income tax return to the extent that the contributions do not exceed the limitations described in section 404 of the Internal Revenue Code. Refer to Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), for more information about deduction limitations. Elective deferrals and investment gains are not currently taxed and enjoy tax deferral until distribution.