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On April 10, 2013, President Obama released his 2014 Fiscal Year "Budget Proposal" (i.e., for the federal government's Fiscal Year beginning October 1, 2013 and ending September 30, 2014). According to the White House, the Budget Proposal should achieve a $1.8 trillion deficit reduction. The Budget Proposal represents a mixture of tax increases and cuts in various federal entitlement programs. Thus far, his proposal has drawn criticism from Republicans for the proposed tax increases and from Democrats for the proposed cuts to entitlement programs. The Budget Proposal is quite lengthy and "The General Explanations of the Administration's Fiscal Year 2014 Revenue Proposals" (the Green Book) published by the Department of the Treasury is itself 246 pages long. A brief summary of some of the more significant tax provisions in the Budget Proposal are summarized below:

1. Budget Proposals Pertaining to INDIVIDUALS:

a. Limitations on Itemized Deductions - The Budget Proposal calls for limiting the value of specified itemized deductions (reported on Schedule A) and income exclusions from Adjusted Gross Income to 28% for certain "high-income" taxpayers. Specifically, the limitation would reduce the value to 28% of the specified exclusions and deductions that would otherwise reduce taxable income in the 33-percent, 35- percent or 39.6-percent brackets, with similar limitations under the alternative minimum tax.


The deductions and income exclusions to be limited include:
  • Tax-exempt state and local bond interest
  • Employer-subsidized health insurance costs for employees
  • Health insurance costs of self-employed individuals
  • 401(K) elective deferrals and IRA contributions
  • Deductions for income attributable to domestic production activities
  • Moving expenses
  • HSA contributions
  • Interest on educational loans
  • Certain (as yet not expressly identified) higher education expenses

b. The Buffett Rule - Individuals whose adjusted gross income exceeds $1 million would pay a minimum tax (called the “Fair Share Tax”) of 30% of the excess of the taxpayer's adjusted gross income over 28% of the taxpayer's charitable deduction for the year.


c. Limit on Accumulated Retirement Benefits Under Tax-Qualified Plans - The Budget Plan proposes to limit contributions and accruals on tax-qualified retirement benefits, including IRAs. Specifically, a taxpayer must determine as of the end of a calendar year whether he has accumulated retirement benefits in all of the tax-qualified retirement plans in which he participates that exceed a benchmark amount (described below). If the benchmark amount is exceeded, then, as a general rule, no further contributions or benefit accruals under the plans should occur in subsequent years, unless and until the taxpayer's accumulated retirement benefits fall below the benchmark amount. For this purpose, the benchmark amount is the amount necessary to provide him with an annual benefit of $205,000 payable as a joint and 100% survivor annuity starting at his 62nd birthday.


d. New Rules to Apply to Federal Estate and Gift Tax Laws - Commencing January 1, 2018, the top marginal estate/gift tax rate will rise to 45%, the estate tax exclusion amount will be lowered to $3.5 million, and the gift tax exclusion amount will be lowered to $1 million. For 2013, the top marginal estate/gift tax rate is 40% and the exclusion amount for both the federal estate tax and the federal gift tax is $5,250,000.

 

2. Budget Proposals Pertaining to SMALL BUSINESSES:


a. Code Section 179 Expensing - The Code Section 179 expensing dollar limit for 2012 and 2013 is $500,000 with a $2 million overall annual limit on the cost of Code Section 179 property placed in service during those years. While these limits are definitely extended for 2013, beyond that the future for this tax deduction is uncertain. The Budget Proposal proposes to make these limits permanent with inflation adjustments to the dollar limitations to be made with respect to any qualified property placed in service after December 31, 2013.


b. Tax Credit for Job Creation - The Budget Proposal would grant to “qualified employers” a one-time tax credit of 10% of the increase in the employer's "qualified wages" paid in the first year after the enactment of the Budget Proposal over the wages it paid in 2012, subject to a maximum credit of $500,000. For this purpose, a "qualified employer" is any non-governmental employer which paid "qualified wages" in 2012 of less than $20 million. "Qualified wages" are those wages subject to Social Security wage withholding.

 

c. Double the Amount of Start-Up Expenses That Can Be Deducted - The Budget Proposal would make permanent the doubling of start-up expenditures that a new business can deduct from $5,000 to $10,000 (less the amount of start-up expenses exceeding $60,000).


d. Automatic Enrollment in Employer-Created IRAs For Employees – “Small employers” which do not sponsor their own tax-qualified retirement plan for their employees would be required to offer to their employees automatic enrollment in an IRA under which the employer would make regular contributions of at least 3% of the employee's wages to the IRA on behalf of the employee through payroll deductions. The automatic enrollment feature would nevertheless permit an employee to opt-out of the arrangement, or elect a lesser or greater percentage of withholding. For this purpose, a "small employer' is any business operating for at least 2 years and that has more than 10 employees.


3. Budget Proposals Pertaining to ALL BUSINESSES:


a. Carried Interests - Under current law, taxpayers can receive partnership interests in exchange for contributions of cash and/or property, as well as in exchange for services. Partnership interests received for services are oftentimes structured as “profit interests” or “carried interests” in the partnership. If the partnership recognizes long-term capital gain, then the service partner who is holding a profits interest (i.e., a carried interest) will in turn report his share of this gain on his federal income tax return as long-term capital gain. If the services partner is an individual, this gain would be taxed at the reduced rates applicable to long-term capital gains.


The Budget Proposal would, instead, tax as ordinary income a partner’s share of any income attributable to an “investment services partnership interest” (ISPI) in an “investment partnership”. This would be the case regardless of the character of the income at the partnership level. Accordingly, even if the service partner is otherwise entitled to a share of the partnership's long term capital gain, this income, as allocated to the service partner, would therefore be taxed to the service partner as ordinary income. In addition, the proposal would require the service partner to pay self-employment taxes on the income.

b. LIFO Repeal - The Budget Proposal would repeal the last-in/first-out (LIFO) method of accounting.

4. Budget Proposals Pertaining to the CLOSING OF LOOPHOLES:

a. Corporate Jets - Under the Budget Proposal, all aircraft that carry passengers could not be depreciated over a recovery period of less than 7 years. Presently, passenger aircraft not flown commercially (i.e., corporate jets) can be depreciated over 5 years, while commercially flown aircraft are depreciated over a recovery period of 7 years.

b. ESOP Dividends - Under current law, as a general rule, corporations cannot deduct dividends paid to their shareholders. At present, a special rule permits the deduction under certain conditions of dividends paid by Subchapter C corporations on stock held by an ESOP created by the corporation. Under the Budget Proposal, only C corporations with annual receipts of $5 million or less could continue to deduct these dividends.

5. Budget Proposals Pertaining to Taxpayers Engaged in Manufacturing and In-Sourcing:

a. Research Tax Credits - Under current law, the Research Credit described in Section 41 of the Internal Revenue Code will expire after December 31, 2013. The Budget Proposal would make the Research Credit permanent and would also increase from 14% to 17% an alternative simplified method of computing the amount of the Credit.

b. Tax Incentives For Locating Jobs and Business Activity in the U.S. - Under current law, there are limited tax incentives for U.S. employers to bring offshore jobs and investments into the U.S. In addition, costs incurred to outsource U.S. jobs generally are deductible for U.S. income tax purposes. Under the Budget Proposal, businesses are entitled to a tax credit of 20% of their expenses in reducing or eliminating a trade or business currently conducted outside the U.S. and starting up, expanding, or moving the same trade or business within the U.S., to the extent that this action results in an increase in U.S. jobs. The Budget Proposal would also disallow tax deductions for expenses incurred to outsource a U.S. trade or business that results in a loss of U.S. jobs.

For additional information regarding this topic, please contact your local UHY LLP professional.