Takeaways from Obama’s Budget Proposal: How Will You Be Affected?

Guest contributor, Michael Reese, Manager in Blackman Kallick’s Tax Department, summarizes the major points from the President’s recent budget proposal. Michael can be reached at 312-980-2907 or mreese@BlackmanKallick.com

     On February 1, 2010, the White House released its FY 2011 budget proposal. As part of the estimated $3.8 trillion budget designed in no small part to rejuvenate the American economy, the Obama administration has included several tax provisions which, if placed into effect, would begin to alter the tax landscape as it exists currently.

     Some of the proposed items are merely extensions or re-issues of provisions we should be familiar with by now. These include:

• Continued indexation of Alternative Minimum Tax (AMT) relief
  
• Extension of the Section 179 expensing threshold of $250,000 through 2010
  
• Extension of the 50% bonus depreciation rules on qualifying property through 2010
  
• Extension of the Making Work Pay Credit through 2011
  
• Extension of the various energy credits (renewable energy, wind, biomass, etc.) passed in the American Recovery and Reinvestment Act of 2009 (ARRA)

     In addition to these stand-bys, the administration is also trying to walk the fine line of generating additional revenues without stunting the nascent economic growth experienced in the last two quarters. To this end, President Obama has had to draw a definitive line in the sand with some of his proposals, coming mid-term elections notwithstanding.

     Expiration of the Bush tax cuts – The administration would allow the individual cuts to expire at the end of 2010, meaning those taxpayers earning more than $250,000 a year (married filing jointly) or $200,000 a year (single filers) could be in line for larger tax liability. Along with the expiration of the 2001 and 2003 tax cuts, the capital gains rate would increase from 15% to 20%. Also of note, the estate tax would be kept at 2009 levels instead of going to zero in 2011 under current law. Estates would be taxed at up to 45% with an exemption of $3.5 million ($7 million for couples).

      Carried Interest to be taxed at “ordinary” rates – This has been in the works at various levels of urgency during the past year, but now it seems as if there may be an endgame to Obama’s campaign rumblings to tax carried interests, in all forms, at ordinary rates as opposed to the capital treatment they currently enjoy.

     International Reforms – Anticipated to raise an estimated $122 billion over 10 years, some of these reforms are repeats of provisions put forth in the FY 2010 budget proposal, which never came to fruition; primary among them are revision to the foreign tax credit regime and bolstering of anti-deferral provisions. One proposal that was not renewed was alteration of the “check-the-box” rules on entity classification. New to the discussion is the plan to treat excess income shifted offshore via transfer of intangible property as subpart F income. There would also be a renewed focus on international tax compliance and the Service’s efforts to have a clearer picture of under-reporting due to use and manipulation of offshore entities.

     Repeal of LIFO method of accounting for inventories – This should already be on your radar for financial statement purposes, assuming International Financial Reporting Standards (IFRS) replace US GAAP. For tax purposes, this change would have the impact of bringing forward potentially large amounts of deferred tax liabilities related to low-cost items currently sitting in a corporation’s inventory. Repeal of LIFO prior to any decision on reporting standards is not set in stone, but the thought is definitely out there.

     Other provisions in the package include making permanent the research and development credit, codification of the “economic substance” doctrine, removal of cell phones from listed property, and increased enforcement efforts by the IRS of existing interest and penalty provisions for non-compliance, as well as increased penalties in certain instances.

     At this point, none of these proposals constitute law, nor have they been formalized in an existing draft of proposed legislation. Although there is some consistency in the arguments set forth by the administration both before and immediately after the election, these positions would have to be subjected to budget committee review, discussion in both the House Ways and Means and Senate Finance committees, and the intricacies of the legislative process prior to any enactment. There is differing opinion within both the Democratic and Republican parties about the various positions and at this point it would be premature to think that the more controversial of the Obama tax proposals as set forth in the budget (expiration of Bush cuts and estate tax reinstatement, LIFO, carried interests) are a done deal. However, the debate does give some indication of how tax policy is being shaped and utilized as expanding public spending deficits continue to be de rigueur. Another thought to bear in mind is that the budget proposals currently do not address any potential revenue raisers associated with either the existing Senate version of healthcare reform or a watered-down version yet to be determined.