Tax Aspects Of The President's FY 2015 Budget

Mar 6 2014, 12:02am CST | by

President Obama released his 218-page FY 2015 federal budget yesterday, and yes, tucked amongst his goals to get out of Afghanistan, reduce dependency on fossil fuels, and fulfill America’s insatiable desire to blow up the moon, there are indeed some proposed changes to the tax law.  

The provisions are largely rebadged versions of items that appeared in previous budgets, and have just as good a chance of being enacted as those prior iterations, which is to say they have no chance at all.

Of course, at this point, any discussion of changing tax policy is largely an exercise in futility, but that shouldn’t stop an inquiring tax geek community from taking a gander at what the Commander in Chief is contemplating. Here’s a review of some of the more noteworthy various provisions and their respective price tags:

Reduce the Value of Certain Deductions and Tax-Exempt Income to 28%

The President’s FY 2015 budget revived a proposal from FY 2013 and FY 2014 that would cap the benefit of certain deductions and exclusions at a 28% tax rate for those in marginal tax brackets in excess of the 28% bracket.

Currently, individual taxpayers with taxable income in excess of $186,350 (if single) and $226,850 (if married) pay tax at rates of 33%, 35% and 39.6% on progressively increasing income. As a result, a taxpayer in the highest tax bracket generally gets a tax benefit of 39.6% for each claimed deduction; i.e., a charitable deduction of $1,000 gives yield to a $396 reduction in tax. (Note, this is before considering the application of the PEASE limitation, which reduces a taxpayer’s itemized deductions by 3% for each dollar adjusted gross income exceeds $300,000 (if married, $250,000 if single). PEASE was reinstated in the 2012 year-end fiscal cliff deal.

Under the President’s plan, however, taxpayers in the 33%, 35% and 39.6% bracket would only receive a tax benefit equal to 28% of a claimed deduction. To illustrate, in our example above, the taxpayer in the 39.6% bracket who makes the $1,000 charitable contribution would only experience a reduction in tax of $280.

In the past, the President has suggested that this 28% limitation would apply not only to common itemized deductions – such as charitable contributions and mortgage interest – but also to two types of tax-exempt income that have long been considered the sacred cows of tax reform: employer-provided health insurance and interest income on state and local bonds.

What’s interesting, however, is that at least one *GASP* Republican seems to have embraced this once-controversial method of raising tax revenue. Just last week, House Ways and Means Committee Chairman Dave Camp pitched a similar proposal that would tax the otherwise-excludable employer-provided benefits and state and local bond interest income at a rate of 10% for certain high-income taxpayers.  

Specific to the President’s FY2015 budget, the approach would apply a tax rate to these items equal to the difference between a taxpayer’s top marginal rate and 28%.  For example, a taxpayer subject to a top statutory rate of 39.6% would pay an 11.6% tax on tax-exempt income.

For a wonderful write-up of the distributional effects of this type of rate limit on certain deductions, see this study performed by the Tax Policy Center.

Price tag: $598 billion in additional tax revenue over the next 10 years.

Imposition of the Buffett Rule:

The need for a “Buffett Rule” – which would ensure that all taxpayers with adjusted gross income in excess of $1 million pay an effective tax rate of at least 30% — has been a popular rallying cry among the President and Congressional Democrats since the eponymous billionaire publicly stated that he paid a higher tax rate than his secretary nearly four years ago. Last year, when the Senate was desperate to avoid sequestration, it proposed formal legislation that pulled back the curtain on just how the Buffett rule would work.

I previously wrote about those mechanics here, but in simple terms, the President’s proposal would add a(nother) alternative minimum tax calculation to the current individual income tax regime. This alternative computation would put an end to the anomalous results experienced by the likes of Warren Buffett and Mitt Romney, who by virtue of the preferential 20% maximum tax rate afforded long-term capital gains and qualified dividends, pay effective tax rates in the low teens on tens or hundreds of millions of taxable income.

Price Tag: $53 billion in additional tax revenue over the next ten years.

Return the Estate Tax Parameters to 2009 Levels/>/>

The compromise between Republicans and Democrats on the expiring estate tax provisions as part of the fiscal cliff deal represented a victory for taxpayers. The estate tax exemption – set at $5.12 million in 2012 – was slated to revert to $1,000,000 in 2013 in the absence of Congressional action, while the estate tax rate would jump from 35% to 55%. While President Obama went into the negotiations hoping to split the difference with an exemption of $3.5 million and a 45% tax rate, he ultimately conceded a $5.25 million exemption amount and 40% tax rate for 2013 and beyond. He amade those amounts permanent, with the exemption indexed for inflation.

Now, the President would like a mulligan. Beginning in 2019, the budget would return the estate tax parameters to 2009 levels: an exemption amount of $3.5 million (not indexed for inflation) and a 40% tax rate.

Price Tag: $131 billion in additional tax revenue over the next ten years.

Tax Carried Interest As Ordinary Income

Again, the real surprise here isn’t that he President has continued his crusade against the private equity “loophole” that (helped) make a rich man of his 2012 opponent, Mitt Romney, but rather that Dave Camp had the guts to piss off a large portion of his party last week by floating the same proposal.

It seems particularly ill-advised for Camp to rile up Wall Street by proposing to have these carried interests – which are currently taxed at preferential rates because they tend to generate long-term capital gains and qualified dividends — instead taxed as ordinary income for two reasons:

1)      The proposal would only generate approximately $14 billion over ten years, and

2)      If you change the way profits interests are taxed, fund managers will simply find another way to be compensated that continues to afford preferential tax rates.

Price Tag: $14 billion in additional revenue over the next ten years, a lot of angry Patrick Bateman lookalikes.

Close the S Corporation Payroll Tax “Loophole”

As I discussed at great length here, S corporation shareholder-employees can often avoid payroll taxes by withdrawing income as distributions rather than compensation. The President would close that down, though he doesn’t say how. Once again, Dave Camp had a similar proposal last week, which couldn’t have made fellow Republican and payroll tax-dodger Newt Gingrich pleased.

International Tax Reform

By now, you’d be within your rights to ask if the President had come up with anything new in the FY2015 budget. And the answer is yes, as he appears to be taking greater aim at multinational corporations than ever before.

In his FY2014 budget, the President put into writing his campaign promise of ditching the current deferral regime of international taxation – whereby a U.S. corporation doing business through foreign subsidiaries generally doesn’t pay tax on foreign profits until they are repatriated to the U.S. — and switching to a worldwide regime, where the same U.S. corporation would pay a minimum tax on the profits earned by the foreign subsidiary.

Last year’s proposal would have generated only $157 billion in revenue over the ten-year budget period. This year’s budget intends to raise $276 billion from international reform over the same period, meaning the President has multinational companies who pay a low effective tax rates due to their overseas operations squarely within his crosshairs. By way of a quick comparison between the two budgets, it appears the President would add the following to his international reform wish list:

  • Restrict deduction of excessive interest of members of financial reporting groups (raising an additional $46 billion over FY2014)
  • Create a new category of Subpart F income for transactions involving digital goods or services (raising an addition $12 billion)
  • Prevent avoidance of foreign base company sales income through manufacturing service arrangements (raising an additional $25 billion)
  • Limit the ability of domestic entities to repatriate (raising an addition $17 billion).

Other Provisions

While the provisions discussed above are sure to draw the most attention, there are also some tax cuts to be found in the budget proposal. Specifically, the President would make expand the child and dependent care credit and extend through 2017 the current exclusion from taxable income for cancellation of indebtedness recognized on a primary residence./>/>

On the President’s corporate to-do list is the expansion and simplification of the R&D credit, the extension of the 100% exclusion for the sale of Section 1202 stock, the repeal of the LIFO method of accounting, and the extension of the higher Section 179 limits.

Two final items of interest:

First, I noticed that there was a provision in the FY2015 that was not present in the previous years’ that would “modify like-kind exchange rules for real property.” What effect this “modification” would have on the existing Section 1031 is unclear, but it would raise $18 billion in revenue over the ten-year window, so one can only imagine that the benefits of deferring gain through a like-kind exchange would be largely curtailed.

Lastly, in his opening remarks the President reiterated the proposal previously set forth in his FY 2014 budget of preventing additional tax-preferred retirement savings by individuals who have already accumulated tax-preferred retirement savings sufficient to finance an annual income of over $200,000 per year in retirement, or more than $3 million per person. While this provision is expected to raise $28 billion in revenue over the ten-year period – which would be used to pay for the President’s Opportunity, Growth and Security initiative – I couldn’t actually find the effects of the proposal anywhere within the numerical budget. But perhaps I’m just stupid.

follow along on twitter @nittigrittytax

Source: Forbes Business


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