These 2 Big Tax Deductions Could Disappear

The threat of higher taxes has been around for years. But earlier this week, the chances of some major disruptions for some taxpayers got a whole lot bigger, as it became clear that several popular deductions are potential targets for raising revenue in post-election federal budgets.

Republican Presidential candidate Mitt Romney gave some details on his plans for a budget proposal should he be elected in November. Although his calls for lower tax rates across the board run counter to Democratic calls to let current rates rise back to decade-ago levels for upper-income taxpayers, a couple of things he proposed actually suggest at least a little bit of common ground. But they could spell problems for taxpayers who take advantage of the provisions he's proposing to cut -- as well as the businesses that thrive on those provisions.

Romney's call to end the mortgage interest deduction for second homes doesn't go as far as some analysts believe is appropriate, but it's a step toward removing one of the largest subsidies in the tax code. By getting rid of some of the incentives of owning homes, the U.S. might help avoid a future repeat of the housing bubble and the financial devastation that followed.

Housing-related tax provisions abound and are highly favorable to homeowners. Deducting mortgage interest and real estate taxes are just two of the benefits. Joint-filing homeowners can also exclude as much as $500,000 in capital gains when they sell their homes -- avoiding tax entirely on that amount. That's a far better tax break than investors get on stocks, bonds, and other investments.

Of course, getting rid of mortgage interest deductions doesn't do the industries that rely on them any favors. Homebuilders Hovnanian (NYS: HOV) and PulteGroup (NYS: PHM) build homes in areas that are popular destinations for second-home buyers, and thus taking away the tax incentive to borrow to purchase second homes could have a direct adverse impact on their demand. Similarly, as Bank of America (NYS: BAC) and Wells Fargo (NYS: WFC) try to boost the credit quality on their loans and demonstrate that they're actually lending the cheap money that the Federal Reserve provides, taking away at least one source of fairly creditworthy borrowers won't help them meet their goals.

The other tax proposal Romney made was to eliminate the deduction for state taxes for high-income taxpayers. That has the potential to be far more divisive, as it hurts taxpayers in high-tax states while leaving untouched those who live in states with low or no taxes.

However, one thing that a lot of people don't realize is that for many, the benefits of state taxes already get eliminated under the current tax code. That's because the alternative minimum tax, which hits millions of taxpayers each year, forces you to reverse itemized deductions on state income and property taxes you pay, making them worthless.

Losing that tax benefit would likely hurt not only individuals who live in those states but also the businesses that rely on hiring skilled workers. Already, no-tax states like Texas and Washington have a huge advantage over high-tax states like California, which partially explains the migration of tech companies toward lower-tax environments over the years. With Apple's (NAS: AAPL) provision for state income taxes eclipsing the $550 million mark in fiscal 2011, there's clearly incentive for companies to make tax-saving moves. Further tilting the scales to hurt high-tax states could have significant competitive effects on the industries that produce high-paying jobs -- exactly the ones that states are courting more than ever.

In an election year, it's highly unlikely that lawmakers will make much progress even on tax proposals that gain bipartisan support, let alone more contentious issues. But as you consider what moves to make with your finances, be sure to think about how taxes might affect you. If you don't, you could end up making ill-advised decisions that will cost you money.

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At the time thisarticle was published Fool contributor Dan Caplinger would love to see a simpler tax code. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Bank of America, Apple, and Wells Fargo, and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo and Apple, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy will never disappear.

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