The Fair Tax Act, Part L
OK, we begin Chapter 8 which is all about Financial Intermediation Services. This is odd stuff to many people so I expect many questions. The first section determines how much of what you pay in financial intermediation service fees is taxable (suffice to say it’s most of it):
SEC. 801. DETERMINATION OF FINANCIAL INTERMEDIATION SERVICES AMOUNT.
`(a) Financial Intermediation Services- For purposes of this subtitle–
`(1) IN GENERAL- The term `financial intermediation services’ means the sum of–
`(A) explicitly charged fees for financial intermediation services, and
`(B) implicitly charged fees for financial intermediation services.
`(2) EXPLICITLY CHARGED FEES FOR FINANCIAL INTERMEDIATION SERVICES- The term `explicitly charged fees for financial intermediation services’ includes–
`(A) brokerage fees;
`(B) explicitly stated banking, loan origination, processing, documentation, credit check fees, or other similar fees;
`(C) safe-deposit box fees;
`(D) insurance premiums, to the extent such premiums are not allocable to the investment account of the underlying insurance policy;
`(E) trustees’ fees; and
`(F) other financial services fees (including mutual fund management, sales, and exit fees).
`(3) IMPLICITLY CHARGED FEES FOR FINANCIAL INTERMEDIATION SERVICES-
`(A) IN GENERAL- The term `implicitly charged fees for financial intermediation services’ includes the gross imputed amount in relation to any underlying interest-bearing investment, account, or debt.
`(B) GROSS IMPUTED AMOUNT- For purposes of subparagraph (A), the term `gross imputed amount’ means–
`(i) with respect to any underlying interest-bearing investment or account, the product of–
`(I) the excess (if any) of the basic interest rate (as defined in section 805) over the rate paid on such investment; and
`(II) the amount of the investment or account; and
`(ii) with respect to any underlying interest-bearing debt, the product of–
`(I) the excess (if any) of the rate paid on such debt over the basic interest rate (as defined in section 805); and
`(II) the amount of the debt.
`(b) Seller of Financial Intermediation Services- For purposes of section 103(a), the seller of financial intermediation services shall be–
`(1) in the case of explicitly charged fees for financial intermediation services, the seller shall be the person who receives the gross payments for the charged financial intermediation services;
`(2) in the case of implicitly charged fees for financial intermediation services with respect to any underlying interest-bearing investment or account, the person making the interest payments on the interest-bearing investment or account; and
`(3) in the case of implicitly charged fees for financial intermediation services with respect to any interest-bearing debt, the person receiving the interest payments on the interest-bearing debt.
OK. So now everyone is probably completely confused. Well, let me see if I can clarify things a bit:
1. You get taxed first on explicit fees: checks, sign-up fees, brokerage fees, ATM fees, etc. Expect some of these fees to go up slightly.
2. You also get taxed on a portion of your interest. Click here for a quick discussion of this.
3. You also get taxed a bit on your interest income (not investment sales, per se but straight interest). The amount the Federal rate exceeds your interest rate return on your investment becomes taxable. This is taken out of interest and remitted by your bank, supposedly.
The amount of tax on interest seems minimal (often less than 7%, but depends on size of interest above Federal rate) but tax on fees is the straight 23%/30% exclusive. I hope that clears things up.
James, I’ve been on the road relocating to NC from Florida for the summer. Your explanation of the implicit tax on investment interest income appears to me to be incorrect. The tax is figured on the amount that the basic interest rate exceeds the rate you are getting, not the other way around as you wrote. I never was able to get my analysis posted, which had several examples of both investment and debt instrument taxes. Perhaps you might take the time to do an example of credit card debt interest tax as well as a typical investment bond example? Your example is OK, but doesn’t go far enough for clarity of this very confusing section.
Thanks!
OK I think you’re right on interest income getting taxed in that regard. I will go back and edit that section.
As for credit cards: I need to find out which Federal rate they use (I believe it’s the short-term rate but I am not sure).
Investment bonds would use the mid-term or long-term rates I believe, but it would depend on the bond maturity period.
Assuming we’re talking credit cards on the short-term rate with monthly payments, the premium on this form of investment is much higher than on home loans, for good reason: there’s much more risk for the money lender.
The May 2007 Federal Short Term Monthly Rate is 4.74%. A typical credit card will charge something like 12% interest for someone with only moderate credit history. That would mean a premium of 7.26% would be taxable interest, and it would raise your 12% credit card interest to 14.18% after taxes.
Now lets try a treasury bond. A 5-year treasury bond would probably have an interest rate of 4.5% (as of today). The mid-term rate for May 2007 is 4.57% for a semi-annual interest payment. The Federal rate exceeds the rate of the bond by 0.07%, which means you would pay 0.021% out as taxes, lowering your return to 4.36%.
It also needs to be noted that your “free” checking account will be taxed because it isn’t really free. You are actually “paying” the difference between the interest you could make on that money and what the bank is giving you. This is one of the “implicitly charged fees.”
If the Federal Rate is 4.5% and your bank is not giving you interest on your checking account, you would pay FairTax on 4.5% (annually) of your checking account balance. If your average balance was $5,000, you would pay ~$67 a year in FairTax on your “free” account.
Technically, it’s the difference between what your bank makes on your money (what you would receive in interest if the bank were paying it to you) and what the bank gives you. This is the “implied charge from the bank” for the service (the “free” checking account).
Why make it hard with all these calculations? It makes no sense. All you have to make an exception to the rule. All goods and services bought by financial intermediation services are subject to the new FairTax, but no FairTax should be charged on money exchanged between the bank and their customers. Any discussion about interest rates, mortgage amounts, and federal funds rate is irrevelant for the purposes of simple and fair taxation. Forget twiddle twaddle.