CCH Tax Briefing Examines Obama’s 2011 Budget Proposals
Friday, February 5, 2010
Posted by: Boomer Consulting, Inc.
In his latest budget, President Obama has unveiled tax proposals for 2011 that generally follow the pattern laid down last year, but with changes in scope and details that reflect a heightened concern with job creation and the rising deficit. CCH has issued a Special Tax Briefing on the measures that would affect millions of individual and business taxpayers. To read the Briefing, click here.
"It’s unlikely that the president’s tax agenda will be passed as a single piece of legislation,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. "Proposals for a job-creation credit may come up for action soon, while others, such as what to do about a host of provisions due to expire for 2011 and some that have already expired, may take much longer.”
A Mixed Bag for Individuals
As he proposed last year, President Obama wants to make permanent the 10-, 15-, 25- and 28-percent tax brackets, which are due to expire after 2010. Last year’s expansion of the earned income tax credit and the child tax credit would also be made permanent, and the child tax credit amount would be set at $1,000 for 2011, rather than reverting to $500.
The president has backed off his earlier proposal to make the Making Work Pay Credit permanent, however. The credit, which lowers most wage earners’ taxes by as much as $400 ($800 for joint filers), is scheduled to expire after this year, and the president proposes extending it only for 2011. He would, however, bring back the "one time” $250 payment for Social Security beneficiaries, disabled individuals and veterans, recipients of Railroad Retirement Board (RRB) benefits, and Supplemental Security Income beneficiaries for one more time in 2010. Certain other retirees not otherwise covered would, as before, receive a "one time” $250 refundable credit in 2010.
"The long-range cost of the Making Work Pay Credit is significant, and its permanent inclusion in the tax code has fallen victim to deficit worries,” Luscombe said.
The president is not retreating on last year’s proposal to make the "saver’s credit,” designed to encourage contributions to a qualified retirement plan or IRA, fully refundable and change the credit to a 50-percent match on contributions up to $500 ($1,000 for joint filers). The amount of savings that would be matched would phase out at a rate of 5 percent of adjusted gross income (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 2012 tax year.
"The credit has always been targeted at wage earners with modest incomes, but in the past, many didn’t realize a tangible benefit because they owed little or no tax in the first place, and the credit was non-refundable,” Luscombe observed.
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.
Expanded Child and Dependent Care Credit, Extended Education Credit
This year, President Obama proposes an expansion of the child and dependent care credit, effective for 2011. The credit can be as much as 35 percent of eligible expenses, gradually decreasing to 20 percent, depending on income. The president proposes increasing the AGI level at which the 35-percent credit begins to phase down dramatically, from $15,000 to $85,000. The 20-percent credit, therefore, would be applied to taxpayers with AGI in excess of $113,000 (rather than above the $43,000 level now in place). The permanently enhanced credit would be available for tax years beginning after December 31, 2010.
This means that taxpayers with incomes up to $85,000 would be entitled to a maximum $1,050 credit ($2,100 for more than one qualifying individual). Those with more than $113,000 AGI could receive a maximum $600 credit with one qualifying individual, $1,200 with two or more would apply.
Once again, the president proposes to make the American Opportunity Tax Credit permanent. 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.
Limited Help for the Unemployed
Individuals who lose their jobs would benefit from a proposed extension of the 65-percent COBRA subsidy program, scheduled to end on February 28, 2010, through the end of this year. Those who lose their jobs after February 28 would be eligible for 12 months of the subsidy.
Not proposed by the president is any extension of last year’s exclusion of up to $2,400 in unemployment benefits from income.
"The administration is shifting the balance more toward job creation this year,” Luscombe said.
Little Good News for High Incomes
For high-income taxpayers, the president once again proposes reinstating the top rates of 36 and 39.6 percent. The 36-percent and 39.6-percent rates would apply to single individuals with incomes over $200,000 and married couples filing joint returns with incomes over $250,000. The $200,000 amount would be reduced for the standard deduction and one personal exemption and indexed for inflation for 2011. The $250,000 amount would be reduced for the standard deduction and two personal exemptions and indexed for inflation for 2011. The 39.6-percent rate would start at the inflation-adjusted level now in place for the 35-percent rate, which for 2010 is $373,650.
This year also sees a repeat of the proposal to reintroduce the limitation on itemized deductions, known as the "Pease” limitation, and the personal exemption phaseout, known as PEP, for those above the $200,000/$250,000 income levels. 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 reinstated Pease limitation.
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. However, rather than taxing qualified dividends as ordinary income beginning in 2011, as under current law, Obama would retain their treatment as capital gains.
"Upper-income taxpayers would actually fare somewhat better under Obama’s proposals than they would under current law, which would repeal almost all the Bush-era tax cuts as of 2011,” Luscombe said. "Retaining the 10-percent and 25-percent brackets benefits them as well as other taxpayers, as does retaining of the treatment of dividends as capital gains. However, they would not fare as well as they have in the past.”
Continuing AMT "Patch,” Extension of Expired Provisions
The 2011 fiscal year budget assumes that Congress will continue to "patch” the alternative minimum tax (AMT) as it did for 2009 and then index it for inflation – or continue one-year "patches” in the future.
Although the president did not identify specific individual "extenders” for 2010, it is likely that Congress will extend a number of provisions sometime in 2010 and make them retroactive to January 1, 2010. These include:
- The state and local sales tax deduction;
- Teacher’s classroom expense deduction of up to $250 annually;
- Higher education tuition deduction for post-secondary education with income phaseouts;
- Tax-free charitable distributions from IRAs for individuals age 70½ and older for distributions up to $100,000 (in lieu of a charitable deduction);
- Additional standard deduction for real property taxes for non-itemizers; and
- District of Columbia First-time Homebuyer’s Credit.
"At present, there doesn’t seem to be any movement to bring back the sales tax deduction for new cars or to extend the First-time Homebuyer’s Credit beyond its expiration on June 30, 2010 for homes under contract by April 30,” Luscombe noted.
Reinstate Estate Tax
While the federal estate tax has officially expired for 2010 and is officially set to return in 2011 at pre-2001 levels, the president’s FY 2011 baseline budget assumes a retroactive reinstatement of the estate tax to January 1, 2010, at 2009 levels.
That’s the thrust of the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Bill of 2009 (H.R. 4154) to permanently extend the estate tax at 2009 exemption rates, passed by the House last year. The bill would impose a 45-percent tax on estates above $3.5 million per individual and $7 million for married couples. The bill is now in the Senate where, at press time, no action has yet been taken.
As in last year’s budget, the administration is also proposing changes to rules regarding valuation, basis and grantor retained annuity trusts to correct what are seen as abusive practices.
Business Tax Breaks
A major initiative for businesses in the budget is $33 billion in small business jobs and wages tax credits. The measure would provide a $5,000 tax credit for every net new employee hired by a qualified small business in 2010, capped at $500,000 for any one firm. The proposal would also reimburse small businesses that increase wages or hours for existing employees for the Social Security payroll taxes they pay on real increases in their payrolls, up to the current Social Security maximum wage base of $106,800.
Another new item is a proposal to remove cell phones from their current classification as "listed property.” This would lift the strict substantiation requirements for business use and make depreciation of cell phones easier. In addition, an employee could exclude the fair market value of personal use of a cell phone provided predominantly for business purposes from gross income.
"The current rules date back to when a cell phone was an expensive novelty,” Luscombe said.
As in the 2010 budget, the administration again proposes to raise the exclusion currently available on gain realized on qualified small business stock from 75 percent to 100 percent. The exclusion is intended to help small businesses raise capital. The administration would eliminate as an AMT preference item the excluded portion of the gain, as well.
"This would be an attractive investment for someone who otherwise might be facing a 20-percent capital gains tax in the future,” Luscombe noted.
The administration also proposes extending the Section 179 expensing and bonus depreciation provisions for 2009 through 2010.
Other extenders specifically included in the 2011 budget include:
- Subpart F active financing (income derived from the active conduct of banking, finance, insurance or similar business is temporarily excluded from subpart F income);
- Tax treatment of certain payments to controlling exempt organizations (excludes these payments from unrelated business income);
- New Markets Tax Credit (allows a credit for making qualified equity investments in designated Community Development Entities);
- Qualified leasehold improvements (improvements eligible for a 15-year Modified Adjusted Cost Recovery System (MACRS) recovery period);
- Qualified restaurant improvements (eligible for a 15-year MACRS recovery period); and
- Empowerment and community renewal zones (eligible for special tax incentives, such as tax-exempt financing initiatives).
"Additional business-related extenders, such as brownfields remediation, may be added by Congress,” Luscombe said.
Business, International, Fossil Fuel Tax Raisers
The president’s 2011 budget also includes his "financial crisis responsibility fee,” a tax on the liabilities of financial institutions with at least $50 billion in consolidated assets. The rate of the fee applied to covered liabilities would be approximately 15 basis points. The fee would be effective as of July 1, 2010.
"This is one of the more controversial elements in the budget,” Luscombe noted.
The budget reiterates a number of revenue raisers from last year, including a repeal of the LIFO inventory method, taxation of carried interest as ordinary income and a package of international taxation "reforms.” The president also proposes to revive Superfund taxes for 10 years commencing with tax years beginning after December 31, 2010.
The 2011 budget proposes to repeal a number of energy tax incentives relating to fossil fuel, effective for tax years beginning after December 31, 2010.
"These provisions follow through on commitments the president made at the G-20 conference in Pittsburgh in 2009,” Luscombe observed.
Finally, the budget proposes a number of "loophole closers” and tighter information reporting to the IRS, but cuts taxpayers one break: they would no longer have to include a non-refundable deposit with their submission of an offer in compromise to settle tax debts.
"Many taxpayers who are in hock to the IRS can’t afford an initial payment, and many are reluctant to make one when the acceptance of their offer is in doubt,” Luscombe said.
CCH Tax Briefings
To read the Briefing, click here. Other timely, current analysis of tax legislation and other federal tax developments can be found at CCH Tax Legislation Coverage.
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