President Barack Obama released his proposed budget for fiscal 2012 that would make several tax credits permanent, including the research and experimentation credit, and provide three more years of AMT relief, but would repeal or limit several other tax breaks. The budget would also set aside $240 million for initiatives to enforce classification of workers as employees rather than independent contractors—the provision is projected to deliver $1.3 billion in revenue by 2014. Simultaneous with the release of the proposed budget, the Treasury Department issued general explanations of its revenue provisions (the Green Book).
Some of the Bush-era tax cuts extended through 2012 would expire under the plan or be limited to certain taxpayers, and proposed limits on itemized deductions such as mortgage interest for wealthy taxpayers will likely trigger a vigorous backlash among homeowners and the real estate industry. Businesses will also be unhappy with the absence of a full repeal of the expanded 1099 reporting rules adopted under the health care reform law. The Administration wants to retain reporting to corporations, with exceptions when reporting would be especially burdensome.
However, clients of estate and gift planners will welcome some provisions in their favor, including permanent portability for spouses of decedents to claim unused portions of estate and gift tax exclusions. Small businesses would generally fare well if the plan were adopted (1099 reporting notwithstanding), as would middle-income individuals, energy companies, and some distressed neighborhoods. Corporations that do not file their returns electronically, however, may face penalties, as would preparers who fail to exercise due diligence on earned income tax credit (EITC) claims.
“We have a lot of work to do in repairing the damage this brutal recession has inflicted on our people, generating millions of new jobs, and seizing the economic opportunities of this competitive, new century,” Obama commented in his message. He also acknowledged that the nation’s growing debt, projected to be $8 trillion in 10 years, requires “hard choices.”
What those choices should be will be subject to considerable debate. House Speaker John Boehner, R-Ohio, immediately criticized the budget as “job crushing.”
“By continuing the spending binge and imposing massive tax hikes on families and small businesses,” Boehner said in a statement, the budget “will fuel more economic uncertainty and make it harder to create new jobs.” The House adopted new rules earlier this year that discourages use of tax revenue raisers.
Below is a summary of the major provisions. The House and Senate Budget committees will review the spending proposals; the tax proposals will be considered by the Senate Finance and House Ways and Means committees.
Individual Tax Proposals
- Limit on the value of itemized deductions to 28% for high-income taxpayers (in the 35% and part of the 33% bracket in 2012);
- Restoration of 39.6% tax bracket in 2013;
- Restoration of 36% tax bracket for single filers with AGI over $200,000 and joint filers with AGI over $250,000;
- Loss of other tax benefits, such as lower capital gains tax rates and elimination of the phase-out for personal exemptions and limitations on itemized deductions, for single filers with AGI over $200,000 and joint filers with AGI over $250,000.
Tax cuts: Permanent extensions of the following income tax benefits extended in 2010 and set to expire in 2012:
- 10% income tax bracket;
- Reduction of 28% and 31% brackets to 25% and 28% respectively;
- Increase in standard deductions for joint filers to eliminate marriage penalty;
- Reduction in capital gains rate but only for taxpayers with AGI of $200,00 or less (single filers) and $250,000 (joint filers);
- Apply 20% rate on qualified dividends for upper income taxpayers that would otherwise be taxed at 36 or 39.6% rate;
- Portability between spouses of unused exclusion for estate and gift taxes.
Permanent extension of tax benefits including:
- Child and dependent care credit—also increases income phase out from $15,000 to $75,000 AGI;
- Employer-provided child care credit;
- Education tax benefits (such as the American opportunity tax credit and exclusion from income for student loan forgiveness and employer-provided education assistance);
- Expanded earned income tax credit for families with three or more qualifying children.
Other tax cut proposals:
- Automatic enrollment individual retirement plan required if employer is in business for two years and has more than 10 employees (employees can opt out);
- $250 refundable tax credit for public sector employees who are ineligible to receive Social Security;
- Three-year AMT patch.
Business Tax Proposals
- Repeal of several deductions and credits used by oil, coal, and gas companies, including expensing of intangible drilling costs;
- Income tax benefit losses described above in “Individual Tax Proposals” that also apply to business owners.
- Elimination of capital gains tax on investments in small business stock;
- Enhancement and permanent extension of the research and experimentation credit;
- Energy tax credits, including tax credit for energy-efficient commercial building property expenditures (replaces existing deduction) and the Sec. 48C credit for investments in qualifying advanced energy projects;
- Permanent extension of increased section 179 expensing for small business;
- Relevant income rate cuts extended after 2012, as described above in “Individual Tax Proposals.”
The Administration is also proposing to require certain employers to provide automatic payroll deposit IRAs available to employees and is offering the employer: (1) a temporary tax credit of $25 per enrolled employee, up to $250, and (2) a three-year increase of the startup tax credit (from $500 to $1,000) for a small employer that adopts a new retirement, SEP or SIMPLE plan.
- Extension of the new markets tax credit for one year (2012);
- Permanent extension of the Build America bonds and expansion of eligible uses;
- Revisions to low-income housing tax credits to provide further incentives for preservation of affordable housing and expand mixed-income housing;
- Designation of 20 Growth Zones with employment and property tax incentives;
- Tax credit to New York City and state for transportation infrastructure around the New York Liberty zone.
Tax Administration and Enforcement
The President’s 2012 budget also makes a number of proposals aimed at reducing the tax gap and reforming the tax system, including changes to 1099 reporting, independent contractor withholding and classification, and several business compliance requirements such as Schedule M reporting requirements and authority for the Treasury Department to require additional information with e-filed Forms 5500.
Following up on a topic raised by Obama in his State of the Union speech, the budget proposal would repeal one aspect of the expanded 1099 reporting requirements enacted by last year’s health care reform legislation.
The Patient Protection and Affordable Care Act expanded the information reporting requirements to include payments to corporations (except tax-exempt corporations) and to include payments for property. The new rule applies to aggregate payments of $600 or more to any recipient made after December 31, 2011. Through 2011, only payments for services require a 1099, and payments to corporations have been exempted from the requirements.
The Administration is proposing to keep the expanded requirement that payments to corporations require a Form 1099 beginning in 2012, but would repeal the requirement relating to payments for property.
The proposal does not address the other expanded Form 1099 requirement that has been imposed on taxpayers who receive income from rental property, starting Jan. 1, 2011.
The AICPA has been actively advocating for the repeal of both 1099 laws and has also asked the Treasury Department to issue guidance as soon as possible to clarify which taxpayers are exempt from the rental payment requirement.
Independent Contractor Withholding
Another proposal would require independent contractors who receive payments of $600 or more from a business to provide a certified taxpayer identification number (TIN) to the business. The business would then be required to verify the contractor’s TIN with the IRS, and, if the TIN cannot be verified by the IRS, the business would be required to withhold a flat-rate percentage of the gross payments.
Contractors could also require businesses to withhold a flat-rate percentage of their gross payments. The contractor could choose withholding at a 15%, 25%, 30% or 35% rate.
Independent Contractor Classification
The Green Book proposes to allow the IRS to issue general guidance on worker classification and to allow it to reclassify workers who have been misclassified either as independent contractors or employees. The IRS is currently prohibited from doing this by section 530 of the Revenue Act of 1978. The IRS would be directed to issue guidance “interpreting common law in a neutral manner” on the issue of employee/independent contractor classification. The Green Book says the IRS would be directed to provide safe harbors and/or rebuttable presumptions, and the guidance would be industry or job specific.
A number of proposals in the proposed budget are designed to increase businesses’ compliance with federal tax law. These include:
- Requiring all corporations and partnerships that file a Schedule M-3 to e-file their return;
- Allowing the IRS to lower the e-filing threshold for other large taxpayers not required to file Schedule M-3;
- Authorizing Treasury to require additional information with e-filed Forms 5500;
- Clarifying when employee leasing companies are liable for clients’ federal employment taxes;
- Repealing the Sec. 847 special estimated tax provisions for insurance companies; and
- Repealing all subsequent changes to the timing and amount of corporate estimated tax payments that differ from the rules in Sec. 6655.
Revenue Raisers/Loophole Closers
The Administration proposes several changes to the tax code for both U.S. and foreign source income to raise additional revenue. Many of these would become effective on the date of enactment.
- Impose a financial crisis responsibility fee on U.S.-based bank holding companies, thrift holding companies, insured depository institutions, and other entities. The fee would be based on the covered liabilities of a financial firm and would be tax deductible;
- Require a corporation that enters into a forward contract to issue its stock to treat a portion of the payment on the forward issuance as a payment of interest;
- Require dealers in commodities, commodities derivatives dealers, dealers in securities, and dealers in options to treat the income from their day-to-day dealer activities in section 1256 contracts as ordinary in character, rather than capital; and
- Reinstate the corporate environmental income tax (Superfund tax). The previous tax was 0.12% on the amount by which the modified alternative minimum taxable income of a corporation exceeded $2 million.
- Defer the deduction of interest expense related to foreign-source income not currently subject to U.S. tax;
- Determine the deemed foreign tax credit on a consolidated basis;
- Tax currently excess returns associated with transfers of intangibles offshore;
- Limit income-shifting through transfers of intangible property offshore;
- Disallow the deduction by insurance companies of reinsurance premiums paid to affiliated foreign insurers not subject to U.S. tax;
- Limit earnings stripping by expatriated entities; and
- Modify the treatment of dual capacity taxpayers.
Finally, the budget proposal includes a number of proposals aimed at simplifying the tax code. These include:
- Elimination of the required minimum distribution rules for IRAs and other tax-favored retirement accounts (such as 401(k) plans and SEPs), if the aggregate value of the taxpayer’s IRA and tax favored retirement accounts was $50,000 or less at the beginning of the calendar year in which the taxpayer turns 70½ (or the year in which he or she dies).
- Allowance of all inherited assets from a tax-favored retirement account or IRA to be rolled over into the beneficiary’s tax-favored retirement account or IRA within 60 days.