President Barack Obama unveiled his proposed budget for fiscal year 2013 on February 13. Included in its 256 pages are several tax reform proposals, including plans to eliminate the alternative minimum tax (AMT), to repeal LIFO, and to tax dividends of high-income taxpayers at ordinary income rates. The budget estimates that the proposed tax changes would raise more than $1.5 trillion over the next 10 years. Overall, the document’s introduction claims that the budget would reduce the federal deficit by more than $4 trillion over that span.
At the same time, the Treasury Department issued its General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals (Green Book). In a prepared statement, Treasury Secretary Timothy Geithner called the proposed budget “a responsible, long-term deficit reduction plan that simplifies the tax code and asks the most fortunate to pay their fair share.”
The budget’s introduction sets out five tax reform principles:
- Simplify the Internal Revenue Code and lower tax rates;
- Reform inefficient and unfair tax breaks;
- Decrease the deficit and protect progressivity;
- Increase job creation and growth; and
- Observe the “Buffett Rule.”
The budget characterizes the “Buffet Rule” as: “No household making over $1 million annually should pay a smaller share of its income in taxes than middle class families pay” (2013 budget, page 39). Its name derives from Warren Buffet’s observation that his effective tax rate is lower than his secretary’s.
The budget proposes that those making more than $1 million should pay at least 30% of their income in tax. The budget’s introduction says that “[t]he Administration will work to ensure that this rule is implemented in a way that is equitable, including not disadvantaging individuals who make large charitable contributions” (id.), but no specifics are provided.
The president is proposing that this “Buffet Rule” replace the current AMT.
To achieve these five tax reform principles, and “[t]o begin the national conversation about tax reform” (id.), the budget offers five specific proposals:
Tax cut expiration and estate tax changes
The budget proposes to allow some of the 2001 and 2003 Bush-era tax cuts to expire. These tax cuts, enacted by the Economic Growth and Tax Relief Reconciliation Act, P.L. 107-16, in 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003, P.L. 108-27, introduced lower tax brackets and a lower capital gains tax rate. The cuts were extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312, and are scheduled to expire at the end of this year.
The budget proposes to let the lower tax rates expire for taxpayers with household income over $250,000 per year (that is, the 36% and 39.6% brackets would be reinstated).
The budget would also:
- Reinstate the limitation on itemized deductions for upper-income taxpayers;
- Reinstate the personal exemption phaseout for upper-income taxpayers;
- Tax qualified dividends as ordinary income for upper-income taxpayers; and
- Tax net long-term capital gains at a 20% rate for upper-income taxpayers.
The budget also proposes returning the estate tax to its 2009 parameters. The current estate tax rate of 35% and estate tax exemption of $5.12 million (as adjusted for inflation) are scheduled to expire at the end of this year and revert to their 2001 levels (55% rate and $1 million exemption). Under the budget proposal, the rate would instead be 45% and the exemption $3.5 million (as they were in 2009).
The budget would also:
- Require consistency in value for transfer and income tax purposes;
- Modify the rules on valuation discounts;
- Require a minimum 10-year term for grantor retained annuity trusts;
- Limit the duration of generation-skipping transfer (GST) tax exemption to 90 years;
- Coordinate certain income and transfer tax rules applicable to grantor trusts; and
- Extend the lien on estate tax deferrals provided under Sec. 6166.
These changes are predicted to reduce the deficit by $968 billion over 10 years.
Cap the value of itemized deductions
The proposed budget would limit the tax rate at which high-income taxpayers can reduce their tax liability to a maximum of 28%. This would affect married taxpayers filing jointly with income over $250,000 and single taxpayers with income over $200,000. (This proposal was also in the president’s 2012 budget but was not enacted.)
This change is predicted to reduce the deficit by $584 billion over 10 years.
Tax carried interests as ordinary income
In another proposal that has turned up several times in the past few years, the budget would tax carried interests in partnerships (such as those held by hedge fund managers and private equity partners) at ordinary income rates, instead of as capital gains. This change is estimated to reduce the deficit by $13 billion over 10 years.
Change depreciation rules for corporate aircraft
Currently, airplanes, such as corporate jets, that are not used in commercial aviation or to carry freight can be depreciated over five years. Commercial aircraft, on the other hand, have a seven-year depreciation period. The budget proposes applying the seven-year deprecation period to all aircraft. It estimates that this would reduce the deficit by $2 billion over 10 years.
Eliminate fossil fuel preferences
In another proposal carried over from last year’s proposed budget, the 2013 budget would repeal a number of tax preferences that are currently available for oil, gas and coal production. It is estimated that this would reduce the deficit by $41 billion over 10 years.
Other tax proposals
In addition to the tax reform proposals discussed above, the budget contains many other specific tax provisions. Among a group labeled “other revenue changes and loophole closers” is a proposal to repeal the LIFO method of accounting for inventories. The Green Book describes this proposal as removing a “possible impediment to the implementation of [IFRS] in the United States” (Green Book, page 130); however, the budget also anticipates that this would generate $73 billion in revenue over 10 years. Under the proposal, LIFO would be unavailable after 2013.
The budget also proposes to continue a large number of expired or expiring provisions through calendar year 2013.
Other proposed tax changes in the budget would:
- Extend the temporary reduction in the Social Security payroll tax rate for employees and self-employed individuals through 2012;
- Extend the 100% first-year bonus depreciation deduction for one additional year;
- Provide a temporary 10% tax credit for new jobs and wage increases;
- Provide additional tax credits for investment in advanced energy manufacturing;
- Provide tax credit for energy-efficient commercial building property expenditures;
- Reform and extend Build America Bonds;
- Extend the American opportunity tax credit;
- Provide for automatic enrollment in IRAs, including a small-employer tax credit;
- Expand the earned income tax credit (EITC) for larger families;
- Expand the child and dependent care tax credit;
- Extend the exclusion from income for cancellation of certain home mortgage debt;
- Provide exclusion from income for certain student loan forgiveness;
- Provide tax incentives for locating jobs and business activity in the United States;
- Provide new manufacturing communities tax credit;
- Target the domestic production deduction to domestic manufacturing activities;
- Enhance and make permanent the research and experimentation (R&E) tax credit;
- Provide a tax credit for the production of advanced technology vehicles;
- Provide a tax credit for medium- and heavy-duty alternative-fuel commercial vehicles;
- Extend and modify certain energy incentives;
- Eliminate capital gains taxation on investments in small business stock;
- Double the amount of expensed startup expenditures;
- Expand and simplify the tax credit provided to qualified small employers for nonelective contributions to employee health insurance;
- Extend and modify the new markets tax credit;
- Designate growth zones;
- Provide tax incentives for transportation infrastructure;
- Modify tax-exempt bonds for Indian tribal governments;
- Allow current refundings of state and local governmental bonds; and
- Reform and expand the low-income housing tax credit.
Proposals affecting foreign income and taxpayers include ones that would:
- Defer deduction of interest expense related to deferred income of foreign subsidiaries;
- Determine the foreign tax credit on a pooling basis;
- Tax currently excess returns associated with transfers of intangibles offshore;
- Limit shifting of income through intangible property transfers;
- Disallow the deduction for nontaxed reinsurance premiums paid to affiliates;
- Limit earnings stripping by expatriated entities;
- Modify tax rules for dual capacity taxpayers;
- Tax gain from the sale of a partnership interest on a lookthrough basis;
- Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment;
- Extend Sec. 338(h)(16) to certain asset acquisitions; and
- Remove foreign taxes from a Sec. 902 corporation’s foreign tax pool when earnings are eliminated.
Several tax administration changes also are proposed. The budget would:
- Require a certified taxpayer identification number (TIN) from contractors and allow withholding if the contractor does not provide a TIN;
- Require e-filing by any entity that must file Schedule M-3;
- Authorize Treasury to require additional information to be included in Form 5500, Annual Return/Report of Employee Benefit Plan;
- Allow the IRS to require prospective reclassification of misclassified workers;
- Revise offer-in-compromise application rules;
- Make repeated willful failure to file a tax return a felony;
- Extend the statute of limitation where a state adjustment affects federal tax liability;
- Require taxpayers who prepare their returns electronically but file their returns on paper to print a 2D bar code;
- Extend IRS math error authority in certain circumstances; and
- Impose a penalty on failure to comply with electronic filing requirements.
Finally, the budget proposes certain tax simplifications, including:
- Simplifying the rules for claiming the EITC for workers without qualifying children;
- Eliminating minimum required distribution rules for IRAs with balances of $75,000 or less; and
- Allowing all inherited plan and IRA balances to be rolled over within 60 days.