The Obama administration submitted a budget proposal on April 10 that asks for $1 trillion in new revenue and hundreds of tax changes. The overwhelming majority of the proposed tax provisions are recycled from previous proposals, including a number of modifications to the U.S. international tax system, proposals to limit the benefit of deductions to 28%, the Buffett Rule minimum tax, the repeal of the last-in, first-out (LIFO) method of accounting and the repeal of tax benefits for oil, gas and coal producers. The budget also includes several new proposals, including provisions to:
limit retirement plan contributions after accounts exceed certain thresholds,
require derivatives to be marked to market with gain or loss treated as ordinary,
eliminate the deduction for employee stock ownership plan (ESOP) dividends for orporations with more than $5 million in annual gross receipts,
increase tobacco and other excise taxes,
impose shareholder liability for certain corporation “intermediary transaction tax shelters,”
exempt businesses with $10 million or less in annual gross receipts from uniform capitalization (UNICAP) rules,
adopt “chained CPI” to provide shallower annual adjustments for tax items pegged to inflation,
repeal technical terminations of partnerships, and
repeal anti-churning rules of Section 197.
The administration’s budget proposal is typically released in February but arrived late this year. The House and Senate have already approved competing budget proposals and are not expected to reach a resolution. The administration’s budget will not affect the budget process and should instead be viewed as a set of policy goals. It largely represents the president’s position in the ongoing debt negotiations. The latest extension of the federal debt limit is set to expire May 19.
The budget generally seeks to raise $1 trillion in new revenue. This figure is consistent with the president’s offers of a potential “grand bargain” on the deficit, which would have raised more than $1.5 trillion in new revenue. The American Taxpayer Relief Act (ATRA) enacted in January already raised $620 billion in new revenue toward the president’s goal.
Republicans have consistently rejected the administration’s call for more revenue and argue that the revenue fight ended when they agreed to the tax increases in ATRA. The budget includes both revenue-raising provisions and tax benefits, but divides them into three distinct groups: baseline adjustments, general budget proposals and proposals to be included as part of revenue-neutral tax reform.
The baseline adjustments would make permanent several individual tax provisions that would otherwise expire after 2017, including the American Opportunity Tax Credit, the increased refundability of the child tax credit and the enhanced earned income tax credit provisions. These changes are estimated to increase the deficit by $100 billion over 10 years. The baseline does not include the extension of “extender” tax provisions scheduled to expire at year-end. The research credit and some other extender provisions are included in the tax reform section, but the administration did not indicate whether it actually supports allowing the other extender provisions to expire.
The budget describes the tax reform proposals as meant for a revenue-neutral tax reform package to be developed by Congress that would eliminate loopholes and subsidies, broaden the base and cut the corporate tax rate. The proposals include both tax cuts and revenue offsets that together would raise an estimated $94 billion over 10 years. This would not allow for more than a single point to be cut from the corporate rate, so Congress is expected to need to make other changes for the tax reform effort to be meaningful. The tax reform package includes many proposals the president has offered before, including provisions that would:
reform the U.S. international tax system,
establish a permanent research credit,
eliminate fossil fuel preferences,
repeal LIFO, and
make a series of changes benefiting small business and addressing various perceived loopholes.
The budget proposals are described as supporting job creation and investment in infrastructure and reducing the deficit by eliminating tax loopholes and reducing tax benefits for higher-income taxpayers. The net effect of these proposals would raise $1 trillion over 10 years. The lion’s share of new revenue would come from controversial provisions to:
provide shallower inflation adjustments through the use of the chained consumer price index (CPI);
impose a new Buffett Rule minimum tax of 30% on income exceeding $2 million (phasing in beginning with $1 million in income); and
limit the value of deductions and other benefits to 28%.
The president has proposed the Buffett Rule and the limit on the value of tax benefits before, but has never proposed using the chained CPI to slow inflation adjustments. The proposal is unpopular with many congressional Democrats because of its effect on entitlement benefits such as Social Security.
The division of the tax provisions into three groups does not appear very meaningful. Administration officials indicated the decision was more presentational than substantive. Provisions that would normally be grouped by common topics – such as the promotion of small business, elimination of tax loopholes and incentives for investment – are divided into different sections in several cases. Many provisions could have been placed in either the tax reform or budget section, and should be viewed simply as the president’s tax proposals regardless of their section. Accordingly, the following summary of the proposals is organized by topic regardless of where a particular item was placed.
General Business Incentives
Research credit
The budget again proposes to make the existing research credit permanent and to increase the alternative simplified credit rate from 14% to 17%, effective for research costs paid or incurred after 2012.
Credit for ‘insourcing’
The president is again proposing a new 20% general business credit for the otherwise deductible expenses incurred in connection with “insourcing” a trade or business, effective for expenses occurred after enactment. The Treasury description defines insourcing as reducing or eliminating a trade or business (or line of business) currently conducted outside the United States, and starting or expanding the same trade or business within the United States to the extent this action generates U.S. jobs. The cost of severance pay and other assistance to displaced workers in the foreign jurisdiction would not be eligible for the credit. This provision is paired with a revenue offset described in the following that disallows deductions for “offshoring transactions.”
Section 179 expensing
This proposal would permanently set the Section 179 small business expensing limit at $500,000, with the phaseout range starting at $2 million. Both figures would be indexed to inflation.
Grant Thornton insight: These amounts are greater than the $250,000 and $800,000 in the tax reform discussion draft from House Ways and Means Char Dave Camp, R-Mich.
QSB stock exclusion
The budget proposes to provide a permanent 100% exclusion for gains on qualified small businesses (QSBs). Last year’s budget would only have extended the 100% exclusion instead of making it permanent. The budget again proposes to extend the rollover period from 60 days to six months for QSB stock acquired. Additional reporting requirements will be provided to ensure compliance.
New credit for manufacturing in areas affected by job losses
This proposal, new in last year’s budget, would again create a new credit program to support investments in communities that have suffered a “major job loss event,” described as a military base closure or reduction or closure of a major employer that results in a “long-term mass layoff.” Similar to the new markets tax credit and Section 48C advanced energy manufacturers credit, taxpayers would have to apply for a limited credit allocation. The president is proposing a $2 billion yearly allocation in 2014, 2015 and 2016.
New job creation credit
The budget again proposes a temporary employer credit equal to 10% of the difference between an employer’s eligible wages in the 12 months following the date of enactment and its 2012 eligible wages, up to a maximum credit of $500,000 per employer. Eligible wages would be those subject to OASDI (old age, survivors and disability insurance) taxes (up to $110,100 in wages in 2012 and $113,700 in 2013). Self-employment income would not count. All corporations that are members of a controlled group would be treated as a single employer, and all employees under common control would be treated as employees of the same employer. The credit would be available to both taxable and tax-exempt employers other than states, political subdivisions or any of their instrumentalities. Public institutions of higher education would be eligible for the credit.
America Fast Forward bonds
The budget proposes a new permanent America Fast Bond program similar to the existing Build America bond program. Interest on America Fast forward bonds would not be taxable, but Treasury would make direct payment to state and local issuers equal to 28% of the coupon interest on the bonds. The proposal would also allow a temporary 50% subsidy rate in 2014 and 2015 for school construction.
Start-up expenditures
The budget again proposes to permanently increase the amount of start-up expenditures that can be deducted, from $5,000 to $10,000, effective for tax years beginning after enactment. The deduction would be phased out dollar-for-dollar for start-up expenditures exceeding $60,000. A similar rule in the discussion draft from House Ways and Means Chair Dave Camp, R-Mich., would apply a $10,000 limit to combined startup and organizational expenditures.
Work opportunity tax credit
The budget proposes to make the work opportunity tax credit permanent.
Exclude small businesses from UNICAP on self-constructed property
Under this new proposal, taxpayers whose average annual gross receipts do not exceed $10 million would not be required to apply the UNICAP rules of Section 263A to property they construct (or have constructed on their behalf) for use in their trade or business. Property that is constructed for sale in their trade or business would continue to be subject to the UNICAP rules. The budget proposal would be effective for costs incurred in taxable years beginning after 2013.
Bond Provisions
The budget would enhance or expand many bond provisions, including provisions to:
authorize refunding of all state and local bonds if the refunding does not increase the amount of principal or lengthen the weighted average maturity of the refunded bonds;
repeal $150 million limit on the volume of outstanding, nonhospital, tax-exempt bonds for the benefit of any one section 501(c)(3) organization; and
increase the limit on qualified highway freight transfer facility bonds.
Energy Provisions
Energy production and property credits
The budget would expand the Section 45 production tax credit to energy produced from new solar facilities and make the credit permanent. The credit would be refundable for projects whose construction begins after 2013. Unlike last year’s budget, this budget does not propose to extend the grant in lieu of the Section 48 tax credit.
New $2.5 billion Section 48C allocation
The president is again proposing to revive the 30% Section 48C credit for investment in property used to manufacture renewable energy equipment with a new allocation of $2.5 billion, down from the $5 billion proposal in the last budget. The 2009 stimulus bill created the credit but with a one-time allocation of only $2.3 billion.
Replacement for the plug-in electric vehicle credit
The president is again proposing to replace the Section 30D plug-in electric drive motor vehicle with a broader credit for vehicles that operate on alternatives to petroleum using technology currently not in wide use (to be determined by the Treasury and the Department of Energy), as long as the technology exceeds the footprint-based target miles-per-gallon gasoline equivalent by 25%. The credit would be based on the vehicle’s efficiency and would be capped at $10,000, and phase out from 2018 to 2020.
Credit for alternative fuel heavy vehicles
The budget again proposes a new credit for alternative fuel vehicles weighing more than 14,000 pounds, equal to 50% of the incremental cost of the vehicles compared to the cost of comparable diesel or gas vehicles. The credit would be capped at $25,000 for vehicles weighing up to 26,000 pounds and $40,000 for vehicles weighing more than 26,000 pounds. The credit would be allowed for vehicles placed in service from 2014 to 2019.
Energy-efficient commercial building credit
The budget proposes to replace the existing $0.60 to $1.80-per-square-foot deduction for property expenditures for energy-efficient commercial buildings to a deduction ranging between $1 per square foot to $3 per square foot, depending on the type of property. The proposal would also create a new deduction based on energy savings performance in a retrofit on a sliding scale from $1 to $4 per square foot. Special rules would be provided to allow the credit to benefit a real estate investment trust (REIT) or its shareholders. This provision differs slightly from the proposal on the Section 179D credit from last year’s budget.
Incentives to Promote Regional Growth
New markets tax credit
The budget for the first time proposes making permanent the new markets tax credit, with a yearly allocation of $5 billion. The new markets tax credit would also be allowed to offset the AMT.
Growth zone incentives
The budget again proposes the establishment of 20 “growth zones” (14 urban and six rural), to be chosen through a competitive application process based primarily on the strength of each applicant’s “competitiveness plan” and its need to attract investment and jobs. For 2015 through 2018, (i) an employment credit equal to 20% of the first $15,000 of wages paid a qualifying growth zone resident (10% if employed outside of the zone) would be available and (ii) 100% bonus depreciation would be available for new property placed in service within the zone.
Low-income housing credits
The budget again proposes changes to reform and expand the low-income housing tax credit, but there are several differences from last year’s version. The budget proposals would generally allow REITs that receive low-income housing tax credits to designate an aliquot portion of their dividends as tax-exempt, to establish new criteria allowing for a wider range of tenants in rent-restricted units and to provide a “basis boost” for a limited number of projects with a federal investment protection designation.
Other incentives
The budget again proposes additional incentives to benefit the transportation infrastructure in or connecting to the New York Liberty Zone. The budget also includes proposals that would modify the rules applicable to tribal economic development bonds.
General Revenue Raisers
Limit the value of tax benefits
The budget includes a proposal to limit to 28% the benefits of many deductions and exclusions. This proposal has been included in the last several budgets, but was expanded last year to include above-the-line deductions and exclusions. It is unchanged this year.
Buffett Rule
The proposal would require all taxpayers with more than $2 million in gross income to pay at least 30% in tax, with payroll taxes (including the new Medicare tax net investment income) counting toward the 30% tax rate. A charitable credit would be provided equal to 28% of the itemized deduction allowed for charitable contributions. The tax would be phased in on a sliding scale between $1 million and $2 million. The Buffett Rule (coined for investor Warren Buffett’s claim that his administrative employees pay a higher tax rate than he does) was first proposed by the president but has been added to the budget for the first time. This version follows the bill introduced by Sen. Sheldon Whitehouse (DR. I.).
LIFO repeal
The budget again proposes the repeal of the last-in, first-out (LIFO) method of accounting, effective for tax years beginning after 2013. Taxpayers would be required to include any LIFO reserve in income ratably over 10 years.
LCM repeal
The budget again proposes to prohibit the use of lower-of-cost-or-market (LCM) and subnormal goods methods, effective for tax years beginning after 2013. Any Section 481(a) adjustment resulting from an accounting method change away from these methods would be included in income ratably over a four-year period from the year of the change.
Deny deductions for outsourcing
This provision would disallow deductions for expenses related to moving operations overseas, which is defined by inverting the definition of “insourcing” for purposes of the new credit on moving operations back to the United States, discussed previously. It is meant to complement the insourcing credit.
Carried interest
The budget again includes a broad proposal to change the taxation of “carried interest” in certain partnerships. The proposal generally follows the approach taken in previous budgets. Income and gain attributable to an “investment services partnership interest” would be taxed as ordinary income and subject to self-employment tax. An investment services partnership interest would be any interest in an investment partnership held by a person who provides services to a partnership that cannot be attributed to “invested capital.” Invested capital is money or property contributed to the partnership for an interest that is allocated capital in the same manner as other capital interests held by partners who do not hold an investment services partnership interest. Broad anti-abuse authority is contemplated, particularly in identifying nonpartnership interests that are the equivalent of an investment services partnership interest.
Other partnership provisions
The budget includes a proposal designed to prevent the duplication of losses exceeding $250,000 where a partner transferee is allocated a substantial loss but the partnership does not have a substantial built-in loss, effective for sales and exchanges after the date of enactment. The budget also includes a proposal limiting a partner’s deduction for its distributive share of expenditures that are not deductible or chargeable to a capital account of the partnership only to the extent of basis, effective for tax years beginning on or after the date of enactment. Finally, the budget includes repeal of Section 708(b)(1)(B), concerning technical terminations of partnerships, effective on or after Dec. 31, 2013.
Deny deduction for punitive damages
Under this proposal, which has been included in the budget for several years, no deduction would be allowed for the payment of punitive damages upon judgment or settlement of a claim, and any recovery of such damages through insurance would be required to be included in income, effective for damages paid or incurred after 2014.
Deny deduction for dividends paid to an ESOP
This new proposal provides that a deduction would no longer be allowed for dividends paid to an ESOP by a C corporation with more than $5 million in annual gross receipts, effective for dividends paid after the date of enactment. The proposal would not affect an ESOP’s ability to distribute such dividends to plan participants without triggering the 10% early distribution penalty.
Limit on contributions to retirement accounts
This year’s budget proposes for the first time to limit the amount that can be contributed by or on behalf of a taxpayer to a tax-favored retirement plan if the balance in all the taxpayer’s tax-favored retirement plans (e.g., IRAs, 401(k) plans, qualified defined benefit and defined contribution plans) exceeds an actuarially determined amount. The budget proposal would not limit earnings in a tax-favored retirement plan, even if contributions are limited under the proposal.
The proposed rule would apply whenever the balance in all of the taxpayer’s tax-favored retirement plans exceeds the amount necessary to provide the taxpayer with the maximum annuity that could be paid from a qualified defined benefit plan under current law. The current maximum annual annuity amount is $205,000 per year. Additional contributions would be allowed for any year in which plan earnings were less than actuarial assumptions. Excess contributions would be taxed currently but could be withdrawn from the plan without further tax during a post-year grace period. The proposal would be effective for tax years beginning on or after Jan. 1, 2014.
Grant Thornton observation: Although the budget proposal does not cap the total amount that can be held in tax-favored retirement plans, it potentially limits or eliminates the ability to make further contributions to such plans if significant balances have been accumulated in the past.
‘Boot within gain’ repeal
The proposal would repeal the “boot within gain” limitation under Section 356 for reorganizations in which the shareholder’s exchange has the effect of the distribution of a dividend, as determined under Section 356(a)(2).
Worker classification
The budget again proposes to make several changes to tighten the rules for classifying workers as employees or independent contractors. The administration would direct the IRS to issue new guidance on worker classification that includes narrowly defined safe harbors and rebuttable presumptions. The IRS could prospectively reclassify misclassified workers whose reclassification is prohibited under current law. Service recipients would be required to disclose to independent contractors the tax and benefit implications of their classification, and independent contractors could request withholding on their payments. The changes are generally proposed to be effective on enactment, but reclassification would not be effective until the first calendar year beginning at least one year after the date of enactment. A transitional period of at least two years would be provided to independent contractors with existing written contracts establishing their status.
Extension of FUTA
The budget again proposes several significant changes to the Federal Unemployment Tax Act (FUTA) tax system, which would:
reinstate and make permanent the federal 0.2% unemployment surtax, effective for wages paid related to employment in 2013 and later,
raise the FUTA wage base from $7,000 to $15,000 in 2016 and index that amount for inflation in subsequent years,
reduce the net federal unemployment income tax to 0.37% effective in 2015, and
suspend interest payments on state unemployment insurance debt and the FUTA credit reduction for employers in borrowing states in 2012 and 2013.
Superfund taxes
The budget would again reinstate superfund taxes, including superfund excise taxes and the superfund environment income tax of 0.12% of corporate income subject to the AMT in excess of $2 million, effective from 2014 through 2023.
Increase tobacco taxes
This new proposal would increase the tax on cigarettes from just under $1.01 per pack to approximately $1.95 per pack and increase all other excise taxes on tobacco products and cigarette papers and tubes by roughly the same proportion beginning in 2014. These amounts would be indexed to inflation.
Repeal tax credit for distilled liquor additives
The budget proposes to repeal the tax credit for distilled spirits with flavor and wine additives.
Deduction for easement contributions for golf course
The budget would prohibit a charitable deduction for the contribution of a partial interest in property for a golf course, effective on the date of enactment.
General aviation passenger aircraft depreciation
Effective for property placed in service after 2013, the budget would require airplanes primarily used to carry passengers to be depreciated using a seven-year life. Airplanes primarily engaged in nonpassenger activities such as crop dusting and aerial surveying would continue to be depreciated using a five-year life.
Financial and insurance industry revenue raisers
Mark-to-market derivatives
This proposal would generally require derivatives to be reported on a mark-to-market basis annually, and all resulting mark-to-market gain or loss would be ordinary. In effect, it would expand the mark-to-market treatment under Sections 475 and 1256 to nearly all derivatives, while denying the 60-40 split of capital gains and losses available for Section 1256 contracts.
