Special CCH Tax Briefing
(RIVERWOODS, ILL., May 15, 2009) –The Obama administration has released the much-anticipated details about its proposed tax cuts and revenue raisers, which CCH has summarized in a Special Tax Briefing, Treasury Releases “Green Book” of Tax Proposals. The Treasury Department’s General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals, also known as the “Green Book”, describes the administration’s tax agenda in considerable detail and projects costs over a ten-year span. CCH, a Wolters Kluwer business, is a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).
To read the CCH Special Tax Briefing on the administration’s proposals, go to http://tax.cchgroup.com/legislation/.
“The proposals are a clear roadmap for Congress,” said George Jones, JD, LLM, CCH senior federal tax analyst. “Given the Democratic majorities in both the House and Senate, many of the president’s recommendations are likely to pass, but some may be scaled back or abandoned.”
A Mixed Bag for Individuals
In general, lower- and middle-income taxpayers would benefit from the president’s proposals while higher-income individuals would see their taxes increase.
All taxpayers would benefit from the extension of the 10, 15, 25 and 28- percent tax brackets, which are due to expire after 2010. Those who are employed, but with low incomes, would benefit by the recent expansion of the earned income tax credit and the child tax credit being made permanent.
Most wage earners have seen their taxes lowered by as much as $400 ($800 for joint filers) due to the Making Work Pay Credit, which is scheduled to expire after 2010. The president proposes making the credit permanent and indexing its phaseout ranges for inflation.
“A number of lawmakers are lukewarm to making this a permanent credit, whose $535 billion cost over ten years would be paid for by revenues from proposed climate change legislation,” Jones noted.
Help For Savers, College Expenses
The president is proposing extra help for people with modest incomes who save for retirement and for a wide range of individuals and families coping with college expenses.
The “saver’s credit,” designed to encourage contributions to a qualified retirement plan or IRA, which is currently nonrefundable, would be made fully refundable and part of the credit would be in the form of a 50-percent match on contributions up to $500. The amount of savings that would be matched would phase out at a rate of 5 percent of AGI in excess of $32,500 for individuals and $65,000 for married couples filing jointly. The $500 amount and the AGI amounts would be indexed annually for inflation for tax years beginning with the 2011 tax year.
The president is also proposing that small businesses that employ 10 or more people and that don’t offer a retirement plan be required to enroll their employees in an IRA to be funded by a payroll deduction, although the employees could opt out.
“This proposal may be one of the administration’s first salvos in reforming retirement savings options,” Jones said. “Treasury officials have indicated that the administration is examining ways to strengthen 401(k)s and other defined contribution plans, such as partial annuitization of 401(k)s.”
The American Opportunity Tax Credit, which debuted in the 2009 Recovery Act as an enhanced and renamed HOPE education credit, would also be made permanent under the president’s proposals. It provides a maximum credit of $2,500 per student for qualified tuition and related expenses – including books – and 40 percent of the credit is refundable. It’s available for students who are enrolled at least half-time in college and phases out ratably for individuals with modified AGI between $80,000 and $90,000 and for married couples filing jointly with modified AGI between $160,000 and $180,000, with the expense amounts and phase-out limits indexed for inflation after 2010.
Little Good News for High Incomes
For high-income taxpayers, the president’s proposals contain little good news. They would lose much of the “tax relief” they received since the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
After 2010, the proposals would reinstate the pre-EGTRRA top rates of 36 and 39.6 percent and apply them to individuals with incomes over $200,000 and married couples filing jointly with incomes over $250,000.
Administration officials had been unclear if the $200,000/$250,000 amounts referred to adjusted gross income or taxable income. Now, however, a Treasury official has said that the 36-percent rate would start to apply to single taxpayers with taxable income above $200,000 less the standard deduction and one personal exemption indexed from 2009, and $250,000 less the standard deduction and two personal exemptions, indexed from 2009, for married couples filing jointly. The administration also proposes to expand the 28-percent bracket to ensure that taxpayers earning less than these amounts would not experience a tax increase.
The current top rate of 35 percent starts at approximately $373,000 in taxable income for individuals and married couples filing jointly. The next highest rate, 33 percent, starts at approximately $172,000 in taxable income for individuals and roughly $209,000 in taxable income for married couples filing jointly.
Taxpayers above the $200,000/$250,000 income levels would also see the reintroduction of the limitation on itemized deductions, known as the “Pease” limitation, and the personal exemption phaseout, known as PEP. In addition, whenever itemized deductions would reduce taxable income in the revived 36 and 39.6-percent brackets, the tax value of those deductions would be limited to 28 percent. The proposal would apply to itemized deductions after they have been reduced by the reinstating the pre-EGTRRA limitation on certain itemized deductions.
“Many lawmakers have distanced themselves from capping itemized deductions for high-income taxpayers, especially as they would affect charitable contributions and mortgage interest,” Jones observed.
Those in the revived 36 and 39.6-percent brackets would also see an increase in their capital gains rates, from the current 15 percent back up to 20 percent after 2010. But the administration is proposing to retain the treatment of qualified dividends as capital gains, which would retain some favorable treatment of dividends even for those in the top brackets. Otherwise, dividends would be taxed as ordinary income beginning in 2011.
“Although not every one of these proposals may pass into law unchanged, it is highly probable, indeed almost certain, that the 36 and 39.6 percent individual marginal income tax rates will return as scheduled after 2010,” Jones said. “With that in mind, higher income taxpayers with deferred compensation packages may want to consider the impact of recognizing that income under a higher rate structure.”
Continuing AMT “Patch”
The 2010 fiscal year budget assumes that Congress will continue to “patch” the alternative minimum tax (AMT) as it did for 2009. The 2009 patch provides higher exemption amounts that keep many taxpayers out of reach of the alternative tax. Additionally, the nonrefundable personal tax credits are allowed to the full extent of the taxpayer’s regular tax and AMT liability.
“Congress is expected to continue to patch the AMT for the immediate future, but prospects for repeal of the AMT are dim as the tax raises huge amounts of revenue, which offsets projected deficits,” Jones noted.
Make Current Estate Tax Permanent
Under current law, the estate tax is scheduled to be entirely repealed in 2010 and then revert to higher pre-2001 rates and lower exemptions starting in 2011. The administration proposes instead to make the current maximum 45-percent rate and exemptions of $3.5 million for individuals, $7 million for couples, permanent.
“Going to no estate tax and then back to 2001 is untenable, according to most Capitol Hill observers, but extending the current rate beyond 2010 will lose significant potential revenue, so the extension may be for only one year,” Jones said. “What is certain is that until a permanent solution is in place, estate planners must continue using multiple alternative will clauses to cover whatever level of estate tax may be imposed in the future.”
The administration is also proposing changes to rules regarding valuation, basis and grantor retained annuity trusts to correct what are seen as abusive practices.
A number of provisions affecting individuals are due to expire at the end of 2009. The administration proposes a one-year extension, through December 31, 2010, of the itemized deduction for state and local sales and use taxes in lieu of state income taxes. The proposals do not mention the following, which have been extended more than once in the past:
- Teacher’s classroom expense deduction of up to $250 annually;
- Higher education deduction for post-secondary education, with income phase-outs;
- Tax-free charitable distributions from IRAs for individuals age 70 1/2 and older for distributions up to $100,000 (in lieu of a charitable deduction);
- Temporary suspension of required minimum distributions for retirement plans beyond the current 2009 tax year moratorium; and
- District of Columbia first-time homebuyer’s credit.
While these provisions are likely to be extended, the fate of some recent temporary tax incentives is less certain. These include:
- The deduction for state and local sales and use taxes paid on the purchase of new motor vehicles;
- Temporary premium assistance for COBRA continuation coverage;
- The $2,400 exclusion for unemployment benefits received in 2009;
- The additional standard deduction for real property taxes for non-itemizers; and
- The first-time homebuyer credit.
“The last two of these have already been extended once, but it’s significant that even when it was extended, the first-time homebuyer credit had an expiration date of December 1, 2009, rather than year-end,” Jones observed.
Business Incentives, Increases
The administration proposals contain some business-related tax breaks, but they also contain a number of business-related revenue-raisers. The breaks include possible extension of an expanded carryback period for net operating losses (NOLs), expansion of a special tax break to help small C corporations raise capital and making the research credit permanent.
This year’s stimulus bill extended the two-year carryback period for certain small businesses 2008 NOLs. Taxpayers may elect to carry back an applicable 2008 NOL three, four or five years. To qualify for the NOL carryback, a small business must have an average of $15 million or less in gross receipts over a three-year period ending with the year giving rise to the loss.
The administration has signaled its support for a lengthened NOL carryback, available to more taxpayers, but it has not specified the extent of the proposed expansion. However, the Green Book’s revenue allocations anticipate NOL tax relief of $27.8 billion in 2009 and $35.7 billion in 2010, far above the $4.7 billion in NOL relief provided under this year’s stimulus bill.
“It is unlikely that the current Congress will approve an extended NOL carryback for all taxpayers regardless of their size,” Jones said. “It is more likely that lawmakers will increase the current $15 million gross receipts ceiling, and do so for 2009 and then wait to see if it is also needed in 2010.”
To encourage the purchase of small business stock, the administration is proposing that the tax rate on sale of the stock be slashed to zero for non-corporate investors if a five-year holding period is met.
“This would be especially valuable to high-income individuals who might otherwise face 20-percent capital gains rates in the future,” Jones said.
The research tax credit has been extended year by year for more than a decade, but the administration now proposes to make it permanent. This involves recognizing a high cost – $74.4 billion over ten years – but it also recognizes the reality that for many companies research requires long-term funding for which the credit is a make-or-break offset.
The Green Book also proposes extending a number of expiring business-related tax breaks, including:
- Subpart F active financing;
- Tax treatment of certain payments to controlling exempt organizations;
- New Markets Tax Credit;
- Qualified leasehold improvements;
- Qualified restaurant improvements;
- Empowerment and community renewal zones; and
- Credits for biodiesel and renewable diesel fuels.
However, the administration has made no proposals regarding these business-related provisions that also expire at the end of the year:
- Indian employment credit against a portion of qualified wages and health insurance costs for qualified employees who work on an Indian reservation;
- Enhanced charitable deduction for contributions of computer technology and equipment by C corporations;
- Enhanced charitable deduction for contributions of food by a business (including a 2009 Recovery Act enhancement for farmers and ranchers);
- Enhanced charitable deduction for contributions of books to public schools by C corporations; and
- Deduction option for Brownfields remediation.
The administration would repeal the last-in, first-out (LIFO) method of accounting for inventories, substituting a first-in, first-out method. Businesses would recognize income stemming from any built-up LIFO reserves on a pro-rata basis over the course of eight tax years, beginning with the first tax year after December 31, 2011. The repeal of LIFO is estimated to generate $65 billion in revenue over 10 years, which would partially pay for the individual and business tax incentives.
“The repeal of LIFO would impact main-street businesses such as retailers and auto dealerships, as well as the oil and gas companies cited by the administration,” Jones noted. “However, the change may be less than monumental since we are moving toward adopting International Financial Reporting Standards (IFRS) for public companies, which don’t permit LIFO anyway. In addition, abandoning LIFO inventory accounting could assist efforts to broaden the corporate tax base, which many see as a prerequisite to eventually lowering the current 35-percent tax rate on corporate income.”
In addition to banning LIFO, the administration would repeal adjustments to inventory allowed for taxpayers who do not use the LIFO method of accounting known as lower-of-cost-or-market. This would prevent companies from writing down the value of inventories to reflect a drop in market price, damage and similar causes.
The administration proposes ending what it sees as loopholes and abusive practices that cost tax revenue and confer what it sees as undue advantages on foreign, rather than domestic, operations.
In early May, the administration previewed four measures, which would generate almost $210 billion in revenue. They are:
- Mandatory deferral of deductions (except research and development expenses) associated with foreign-source income not currently subject to U.S. tax;
- Computation of the deemed foreign tax credit based on the amount of the consolidated earnings and profits of all foreign subsidiaries repatriated to the U.S. taxpayer;
- Matching that would prevent the separation of creditable foreign taxes from the associated foreign income in the case of hybrid arrangements; and
- Required check-the-box election of corporation status for certain overseas “disregarded entities” established by U.S. businesses (with first-tier foreign eligible entities excepted).
In addition to giving more detail to these highly controversial proposals, the Green Book contains six additional “international loophole closers” that could raise a further $11.6 billion. They would:
- Limit the ability of U.S. multinationals to shift income outside the U.S. through intangible property transfers;
- Limit current earnings-stripping practices by expatriated entities by tightening the availability of an interest deduction paid by an expatriated entity to related persons;
- Repeal the boot-within-gain cap now available for earnings and profits of foreign subsidiaries in cross-border reorganizations;
- Repeal the 80/20 company rules that effectively treats as foreign-source income certain dividends and interest paid by a domestic corporation if at least 80 percent of its gross income over three years is foreign source;
- Revamp the withholding rules on dividends to prevent avoidance by foreign portfolio investors through equity swaps; and
- Modify the foreign tax credit rules for dual capacity taxpayers to allow foreign levies to be a creditable tax only if the foreign country generally imposes an income tax.
“The administration did not propose complete repeal of the deferral system, which generally allows a U.S.-based company to defer U.S. taxation on its foreign-source income until the earnings are repatriated,” Jones said. “Instead, the proposals are more tailored and are designed to limit the ability of a U.S. taxpayer to take deductions for offshore expenses against U.S. income. However, some lawmakers have expressed initial reluctance over enactment of international tax reforms for fear of further harm to an already fragile economy.”
The Green Book also contains a number of proposals aimed at curtailing tax evasion using offshore bank and other financial accounts by strengthening the information reporting and withholding systems. The administration proposes clarifying the “economic substance” doctrine to crack down on abusive transactions and taxing the “carried interest” of certain partners – such as hedge fund managers – as ordinary income.
“These ambitious proposals cover a vast range of subjects, and are bound to spark interesting debate as they work their way into law,” Jones said. “In many areas, they mark a true change from the course that had been set by previous legislation.”
About CCH, a Wolters Kluwer business
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