Tax Proposals from the President’s 2013 Federal Budget
President Obama submitted a fiscal 2013 federal budget to Congress on February 13, 2012. On the revenue side, the President’s proposals blend several familiar ideas along with a number of new initiatives. The FY 2013 budget provides further detail regarding some of the President’s tax proposals unveiled in his January 24, 2012 State of the Union Address. If enacted by Congress, these proposals would impact individuals, businesses, exempt organizations, and taxpayers of all types.
Below are highlights from a dozen of the President’s more significant tax proposals:
Individual Income Tax Rates
The President has continuously expressed his opposition to the extension of the Bush-era tax cuts for higher income individuals. In the President’s proposal, he would reinstate the 36 percent and 39.6 percent tax brackets for high income taxpayers. At the same time, the President would extend the tax rate brackets of 10, 15, 25, and 28 percent, and eliminate the 33 and 35 percent tax rate brackets. The revised marginal tax rate brackets would be effective for taxable years beginning after December 31, 2012.
The President proposes to increase the tax rate on qualified capital gains from 15% to 20% for higher income taxpayers. The increased rate would apply to single individuals with incomes over $200,000 and married taxpayers filing a joint return with incomes over $250,000. Further, for taxpayers with incomes in excess of these thresholds, qualified dividends would be taxable at ordinary income rates. Both of these changes would be effective for taxable years beginning after December 31, 2012.
Limitation on Itemized Deductions/Personal Exemption Phaseout
The Administration proposes to reinstate the limitation on itemized deductions and the phase-out of personal exemptions for upper-income taxpayers. Itemized deductions would be reduced by 3 percent of the amount by which adjusted gross income exceeds statutory thresholds, but not by more than 80 percent of the otherwise allowable deductions. The amount of each personal exemption would be reduced by 2 percent of the exemption amount for each $2,500 or fraction thereof by which adjusted gross income exceeds statutory thresholds. The thresholds for both provisions would be $200,000 for single individuals and $250,000 for married taxpayers filing joint returns. This change would be effective for taxable years beginning after 2012.
The President’s budget anticipates the future repeal of the Alternative Minimum Tax (“AMT”) for individual taxpayers. The AMT would be replaced by a so-called “Buffett Rule”. The Buffett Rule name is associated with legendary investor Warren Buffett and his public comments regarding his effective income tax rate in comparison to the rate paid by his secretary. Under the Buffett Rule, taxpayers making more than $1 million a year would be required to pay a minimum effective tax rate of at least 30 percent.
The President’s budget does not include a specific Buffett Rule provision with an effective date. Instead, the President has asked Congress to continue to extend the AMT “patch”, until Congress can pass measures consistent with the principles of the Buffett Rule. In this way the President hopes to keep the Buffett Rule alive as a future goal of comprehensive tax reform after 2012.
President Obama has proposed to scale back some of the favorable estate tax provisions in the 2010 Tax Relief Act, which are scheduled to expire after 2012. In their place, the President proposes to reinstitute the federal estate tax parameters that were in effect as of calendar year 2009, including a top estate tax rate of 45 percent and an exemption amount of $3.5 million. The proposal would be effective for estates of decedents dying after December 31, 2012.
Manufacturing Communities Tax Credit
The purpose of this proposal by the President is to provide federal support for investment in communities that have experienced a major job loss, such as the closure of a military base or a mass lay-off. The credit would be structured similarly to the mechanism of the New Markets Tax Credits or as an allocated investment credit similar to the Qualifying Advanced Energy Project Credit.
The last-in, first-out method (“LIFO”) is an inventory cost flow assumption that assumes the most recently items most recently purchased or produced by the taxpayer are the first items sold. As compared to other cost flow assumptions, LIFO generally results in lowest cumulative taxable income being reported over the operating life cycle of the taxpayer’s business, as long as the taxpayer continues to make investments in inventory. The President’s budget proposes repealing the LIFO method. The lower-of-cost-or market (“LCM”) inventory accounting method would be repealed as well.
To accomplish LIFO repeal, taxpayers would be required to write up their beginning LIFO value in the first taxable year beginning after December 31, 2013. However, this one-time increase in gross income would be taken into account ratably over ten years, beginning with the first taxable year after December 31, 2013. The repeal of the LCM method would be effective for taxable years beginning after December 31, 2013.
The Administration’s proposal would tax as ordinary income a partner’s share of income from “investment services partnership interest” (“ISPI”), regardless of the character of the income at the partnership level. Accordingly, such income would not be eligible for the reduced rates that apply to long-term capital gains. An ISPI would include a carried interest in an investment partnership that is held by a person who provides services to the partnership. To the extent the partner’s share of income from an ISPI is attributed to “invested capital”, the partner’s income would not be recharacterized from capital gain to ordinary income.
The President’s carried interest proposal would be effective for taxable years ending after December 31, 2012.
Repeal of Oil/Gas and Coal Tax Incentives
The President has proposed to repeal credits and deductions available to oil, gas and coal producers for tax years beginning after December 31, 2012, including the enhanced oil recovery credit, the expensing of intangible drilling costs, the exception to passive loss limitations for working interests in oil and natural gas properties, along with numerous other incentives. The President has proposed to increase the amortization period from two to seven years for geological and geophysical expenditures incurred independent producers in oil and gas exploration paid or incurred after December 31, 2012. Additionally, the Section 199 “Manufacturing” deduction would be eliminated for oil, gas and coal producers.
Past legislation provided for 100 percent bonus depreciation through the end of 2011. The President’s budget proposal extends 100 percent bonus depreciation through the end of 2012.
Tax Credit for New Jobs/Wage Increases
Qualified employers would be eligible for a new, temporary credit. The credit would be equal to 10% of the increase in the employer’s eligible 2012 wages over the prior year (2011). The maximum amount of the increase in eligible wages would be $5 million with a maximum credit of $500,000. The proposal would be effective for wages paid during the one year period beginning on January 1, 2012.
Incentives for Insourcing/Disincentives for Outsourcing
The President’s budget proposes to create a new general business credit against income tax equal to 20% of the eligible expenses paid or incurred in connection with “insourcing” a U.S. trade or business. Insourcing is described by the President’s budget as reducing or eliminating a trade or business or line of business currently conducted outside the U.S., and starting up or expanding the same trade or business within the U.S., to the extent that this action results in an increase in U.S. jobs.
Meanwhile, the President’s budget would disallow deductions for expenses paid in connection with outsourcing a U.S. trade or business. Both proposals would be anticipated to be effective for expenses paid or incurred after the date of enactment.
Notably absent from the Administration’s budget proposal was details about corporate tax reform, which has been a recurring theme in Presidential addresses over the past year. President Obama has said he would support reducing the corporate tax rate in exchange for the closing of unspecified tax loopholes.
Given the current landscape of a divided Congress and the politically charged atmosphere in this Presidential election year, most commentators do not expect many of the President’s proposals to result in actual 2012 tax legislation. Regardless of what happens in November, the lame duck Congress that returns to work after the November elections will take up the fate of the Bush-era tax cuts. The outcome of the November election will most likely determine whether many of the other items in President Obama’s 2013 budget either fade into history or become strong contenders for tax legislation at the end of 2012 and into 2013.
Richard Woods, CPA, Senior Manager