President’s FY 2016 Budget Promotes Tax Incentives for Middle Class Through International Tax Reform, Taxes on High-Income Individuals

President Obama’s fiscal year (FY) 2016 revenue proposals are designed to further middle-class economics, a senior Treasury official said at the February 2 press conference that took place shortly after the proposals’ official release. The FY 2016 proposals also aim to reform international taxation, particularly with respect to accumulated foreign earnings, simplify the tax system for small businesses, and enhance and streamline the myriad of education incentives available to middle-class individuals.

There are approximately 160 total proposals in the president’s FY 2016 budget release, of which 27 are new, 45 are modified or combined from proposals made in 2014, and 85 are substantially the same as proposals issued for FY 2015, explained the Treasury official. “The key revenue raisers in the budget this year will help make the tax system work better and become more equitable in part by closing loopholes and eliminating ineffective or counterproductive tax subsidies. In contrast, where tax incentives have shown value, the budget increases emphasis on them and refocuses attention on those most likely to have the desired effect,” the official stated.

The Obama administration’s series of proposed revenue raisers for FY 2016, which take shape principally in the form of increased taxes on high-income individuals and new taxes on foreign earnings of U.S. multinational firms, are intended to produce needed funding for education, scientific research and infrastructure in a fiscally responsible manner, the Treasury official said. “All in all, the budget this year puts out the administration’s view of what a tax system should look like,” according to the official. “[A tax system should] be more equitable and raise a sufficient amount of resources to pay for the medium and long-term needs of the country.” The tables issued alongside the proposals indicate that the administration’s budget would raise approximately $1.5 trillion over the 10-year budget window. The Treasury official added that, “We also have a number of proposals dedicated to a reserve pool for long-run revenue neutral business tax reform.” These proposals, which create a reserve fund of approximately $141 billion, are not included in the budget deficit table, the official noted.

U.S. International Tax Reforms

The Obama administration budget’s international tax proposals represent an attempt to build a hybrid territorial/worldwide system of international taxation. New for the FY 2016 budget is a two-part solution to allowing foreign profits to be repatriated into the U.S. to provide domestic growth without foregoing revenues that otherwise should have been taxed:

19-percent minimum tax on foreign income. The administration proposed a minimum cumulative tax of 19 percent on earnings of a U.S. corporation that has stock in a controlled foreign corporation (CFC) or that has foreign earnings from a foreign branch or from performing services abroad. The tax would be imposed on current foreign earnings regardless of whether they are repatriated to the U.S. This would allow all foreign earnings to be repatriated without further U.S. taxes.

14-percent, one-time tax on previously untaxed foreign income. In connection with the imposition of a minimum tax, the administration would impose a one-time, 14-percent tax on earnings accumulated in CFCs that have not previously been subject to U.S. tax. A foreign tax credit would be allowed. The accumulated income could then be repatriated to the U.S. without further tax. The proposal would apply to earnings accumulated for tax years beginning before January 1, 2016. The tax would be payable ratably over five years.

Additional proposals designed to reform the U.S International Tax System include measures that would:

— Restrict corporate inversions by limiting the ability of U.S. corporations to expatriate by broadening the definition of an inversion to a greater than 50-percent ownership of the foreign parent by the former U.S. shareholders (replacing the current 80-percent test);

— Provide tax incentives for locating business activity in the U.S. and remove tax deductions for shipping jobs overseas;

— Limit the shifting of income through intangible property transfers;

— Close loopholes under Subpart F;

— Restrict the use of hybrid arrangements that create stateless income; and

— Restrict deductions for excess interest of members of financial reporting groups.

Small Business Tax Relief/Simplification

Proposed tax relief for small businesses in the FY 2016 budget follows the FY 2015’s budget recommendations:

— Expand and permanently extend Code Sec. 179 expensing to a $500,000 for 2015 and $1 million in 2016, with inflation adjustments thereafter;

— Expand use of the cash method of accounting to small businesses with less than $25 million in average annual gross receipts;

— Permanently extend the 100 percent exclusion for income from tax qualified small business stock held by individuals for more than five years;

— Increase and consolidate the deduction for start-up and organizational expenditures; and

— Expand the credit for small employers to provide health insurance to apply to up to 50 (rather than 25) full-time equivalent employees, with phase out between 20-and-50 employers (rather than between 10 and 25).

Middle-Class Tax Relief

The tax-side of the administration’s proposals for middle-class tax relief focuses primarily on child care, education and two-earner couples:

— $3,000 maximum credit per child for care for children under age 5. The child and dependent care credit under Code Sec. 21 would be increased to a maximum of $3,000 per child for expenses incurred for the care of children under age 5 to enable gainful employment of the parent(s) or other qualified taxpayer. The regular credit for those ages 5 through 12 would also phase out at higher income levels. Flexible spending accounts for child care, however, would be eliminated.

— $500 “second earner” tax credit for dual-earner couples. This new credit would be fully phased out at adjusted gross income (AGI) over $210,000.

— Overlapping education provisions would be consolidated, and the $2,500 American Opportunity Tax Credit (AOTC) would be expanded to include more students. The AOTC would be permanently available for the first five years of post-secondary education (replacing the Hope tax credit entirely); a larger portion of the AOTC would be refundable, and the credit amount would be indexed for inflation each year. The credit would also be better coordinated with Pell Grants. In exchange, the administration proposed the repeal of the Lifetime Learning Credit and student loan interest deduction to simplify the overall scheme for education benefits.

Revenues for Middle-Class Tax Relief

The administration highlighted three principal reforms through which it says many of its investments in the middle class will be funded:

— Elimination of “stepped up basis” at death; similar gift consequences. Transfers of appreciated property generally would be treated as a sale of the property, with the donor or deceased owner of the appreciated asset realizing capital gain at the time the asset is given or bequeathed. Generally, a $100,000-per-person exclusion would exist for inherited appreciated assets, along with exceptions for surviving spouses, small businesses, charities and residences, among others.

— Raising the top effective capital gains and dividends rate to 28 percent. This rate increase would include a rise in the top capital gain and qualified dividend rate from 20 percent to 24.2 percent, which rises to 28 percent when the current net investment income tax of 3.8 percent is included.

— Imposition of a tax on large financial institutions for highly leveraged activities. Large financial firms would pay a 7-basis point fee on their liabilities.

Additional revenues would be raised from “the wealthiest” in the form of provisions, among others, that have also appeared in prior years, including:

— Limiting to 28 percent the value of itemized deductions and other tax preferences.

Implementing the “”Buffett Rule.” This rule, which is a carryover from prior year budget proposals, would require the wealthy to pay at least a 30-percent effective tax rate.

— Taxing carried interest profits as ordinary income. This income is earned by hedge fund managers and others.

— Reinstating 2009 estate and gift tax rates with lower exclusions (generally at 45 percent at $3.5 million for estates and $1 million for gifts.

Other Pro-Business and Regional-Growth Proposals

Provisions directed toward business, many of which have appeared in prior years, include, among others:

— An enhanced and permanent research tax credit and other incentives;

— Extend and modify incentives to hire veterans and other employment tax credits;

— Modify and permanently extend the renewable electricity production tax credit and the investment tax credit;

— Provide a new carbon dioxide investment and sequestration tax credit;

— Modify and permanently extend the New Markets Tax Credit;

— Modify and permanently extend the Low-Income Housing Tax Credit;

— Provide and expand America Fast Forward Bonds; and

— Provide qualified public infrastructure bonds.

IRS Budget

President Obama’s FY 2016 budget would fund the IRS at $12.9 billion, representing an increase of nearly $2 billion compared to FY 2015. The president called for significant increases in operations support, taxpayer services and enforcement.

“The funding would counter five years of declining budgets for the IRS, which have deeply eroded our ability to provide critical services for taxpayers, offer appropriate tax enforcement protections and plan for future improvements,” IRS Commissioner John Koskinen said in a statement. Koskinen predicted that additional enforcement funding would more than pay for itself. “For every dollar invested in these programs, there can be returns ranging from 6-to-1 and even up to 20-to-1 in some initiatives,” he added.

Congressional Reaction

While Republican leadership universally panned President Obama’s budget blueprint, with most stating that it appeared to follow in the same “tax-and-spend” vein as past budget proposals, they also suggested there might be room for compromise.

“For six years the president has pursued higher taxes and higher spending, and our economy has paid the price. This budget is simply more of the same,” said House Ways and Means Committee Chairman Paul Ryan, R-Wis. Ryan added, however, that he hoped to find some common areas within the framework of tax reform in order that Republicans could “work with this administration” on some of its proposals. “We’re going to be focused on an optimistic agenda to move America forward, and I hope the president is willing to rethink his tax-and-spend approach so we can get things done for the American people,” said Ryan.

Speaking on ABC’s “Meet the Press” on February 1, Ryan was more optimistic that he could find common ground with the president. On tax reform, Ryan believed there was room for compromise. “We’ll see if we can get a tax reform package done,” he said. When asked if there were areas where the two could meet on taxes, Ryan answered in the affirmative. “We want to work with this administration to see if we can find common ground on certain aspects of tax reform and we want to exhaust that possibility.” Ryan cited the Earned Income Tax Credit and child tax credit as areas where he thought there was some room for trade-offs between Congress and the administration.

Senate Finance Committee Chairman Orrin G. Hatch, R-Utah, labeled the president’s budget “a retread of the same top-down redistributive policies…a $4-trillion government spending spree propped up by massive new tax hikes.” Hatch also said he hoped the administration would change its course and “move past political talking points and start working with Republicans and Democrats to find consensus on policies that will expand the economy.”

Senate Majority Leader Mitch McConnell, R-Ky., also spoke out against the president’s budget plan, saying it was “another top-down, backward-looking document.” McConnell did state, however, that the new Congress will focus on ways to help the middle class, an area that the president and Democrats say they want to place their focus. House Speaker John Boehner, R-Ohio, said the president’s budget does not balance and “contains no solutions to address the drivers of our debt, and no plan to fix our entire tax code to help foster growth and create jobs.”

Democrats, for the most part, were relatively muted in their response to the budget plan, with most referring to it as a good starting point. “Budgets are all about priorities, and I am very glad that the president’s budget lays out a vision for a government and an economy that prioritizes jobs, middle class families, and broad-based economic growth,” said Senate Budget Committee ranking member Patty Murray, D-Wash. “This budget proposal is a strong starting point for Democrats and Republicans.”

By Jeff Carlson, Jennifer Cordaro, George Jones, and George Yaksick, Wolters Kluwer News Staff

 

AUTHOR

Wolters Kluwer Tax and Accounting

Wolters Kluwer Tax and Accounting is a leading provider of software solutions and local expertise that helps tax, accounting, and audit professionals research and navigate complex regulations, comply with legislation, manage their businesses and advise clients with speed, accuracy and efficiency. Wolters Kluwer Tax and Accounting is part of Wolters Kluwer N.V. (AEX: WKL), a global leader in information services and solutions for professionals in the health, tax and accounting, risk and compliance, finance and legal sectors. We help our customers make critical decisions every day by providing expert solutions that combine deep domain knowledge with specialized technology and services. Wolters Kluwer reported 2016 annual revenues of €4.3 billion. The company, headquartered in Alphen aan den Rijn, the Netherlands, serves customers in over 180 countries, maintains operations in over 40 countries and employs 19,000 people worldwide. Wolters Kluwer shares are listed on Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices. Wolters Kluwer has a sponsored Level 1 American Depositary Receipt program. The ADRs are traded on the over-the-counter market in the U.S. (WTKWY).

All stories by: Wolters Kluwer Tax and Accounting