President Obama was re-elected, setting the stage for difficult negotiations over expiring tax provisions. Key issues include the Bush-era tax cuts, automatic spending cuts, and over 50 expiring tax extenders. Obama supports allowing tax cuts to expire for higher incomes and increasing rates on capital gains and dividends for them. The fiscal cliff forces Congress to act by year-end on these issues.
1. CCH Tax Briefing
Post-Election Tax Policy
November 8, 2012 Special Report
Highlights
Obama Wins Second Term; Agreement
Rate Increases For Higher
On Taxes/Spending Possible By Year-End
P
Brackets On Horizon
resident Obama secured a second step toward deficit reduction with revenue
Certain Itemized Deductions term in office November 6, 2012, raisers within four to six months. In the
in the end winning the Electoral interim, both sides may have to settle for a
Likely To Be Curtailed
College by a wide margin. The President’s temporary extension of some of the expiring
Fiscal Cliff To Force re-election now sets in motion what will provisions, including some income tax rates,
Congressional Action likely be difficult negotiations between and leave the long-term fate of the Bush-era
Democrats and Republicans over the fate of tax cuts and more to the 113th Congress,
Permanent AMT Solution the Bush-era tax cuts, nearly $100 billion which will meet in January 2013.
May Be Found in automatic spending cuts, and the more
than 50 expiring tax extenders, which in- COMMENT. Less than 24 hours after
Enhanced Business clude the alternative minimum tax (AMT) the results were in, House Speaker John
Expensing Up For Renewal patch for tens of millions of taxpayers. The Boehner, R-Ohio, said Democrats and
President’s re-election has also significantly Republicans should focus on “common
Education Tax Breaks Likely changed the dynamics for reaching an even- ground” to address the so-called “fiscal
Preserved tual agreement over long-term tax reform. cliff.” Lawmakers are due back in Wash-
ington on November 13. They will break
Many Affordable Care Act IMPACT. Year-end tax strategies will de- for Thanksgiving later in November and
Provisions Set To Go mand more urgent attention from higher- will return in early December. Although
income taxpayers as the result of President the scheduled work period is short, there
Corporate Tax Reform To Obama’s re-election. The President has con- have been reports of lawmakers engaging
Become Priority sistently called for higher tax rates on indi- in behind-the-scenes discussions about
viduals with incomes above $200,000 and taxes and deficit reduction in the weeks
families with incomes above $250,000 and before the election. These discussions
continuation of the current lower tax rates could help kick-start serious negotiations
for others. He campaigned on reinstatement between the White House and the GOP.
Inside of the 36 percent and 39.6 percent income
Post-Election Congress.......................... 2 tax rates for higher-income individuals. COMMENT. Whether any eventual com-
The President also advocated a maximum promise hammered out between Congress
Looming Deadlines................................ 2 capital gains rate increase from 15 percent and the Obama Administration would
Individuals................................................ 2 to 20 percent and a dividend rate rise from extend lower income tax and capital
Estate and Gift Tax................................. 4 15 percent to 36 percent or 39.6 percent gains/dividends rates for one more year,
Payroll Tax Holiday................................. 4 for higher-income taxpayers. His re-election into 2013, or allow the higher top rates
also ensures that the 3.8 percent Medicare in 2013 to start at temporarily higher
Businesses................................................ 4 contribution surtax on net investment in- income levels than initially proposed,
Tax Extenders.......................................... 5 come will go into effect on January 1, 2013, remains speculative. In the meantime,
Education................................................. 6 and continue into the foreseeable future. higher-income taxpayers must decide
Health Care.............................................. 7 whether to wait-and-see … or secure the
Before the election, President Obama had benefit of current rates now, through ac-
Possible Blueprints for Tax Reform..... 8 predicted Democrats and the GOP could celerating income, postponing deductions/
reach a “grand bargain” that permanently re- credits, harvesting appreciation/capital
solves the fate of the Bush-era tax cuts, low- gains, having closely-held corporations
ers the corporate tax rate and takes a serious declare special dividends, closing business
3. November 8, 2012
3
Congress could extend all of the Bush-era IMPACT. As part of the automatic sun- over $200,000 and married taxpayers filing
tax rates through 2013 or, in a deadlock, set of Bush-era tax benefits, after 2012 a joint return with incomes over $250,000.
take no action and allow the Bush-era tax higher-income taxpayers also would once Regarding dividends, single individuals
rates to sunset. Full sunset for lower and again be subject to the Personal Exemp- with incomes over $200,000 and families
middle-income taxpayers—which would tion Phaseout (PEP) and the Pease Limi- with incomes over $250,000 would pay tax
reinstate a 15, 28, 31, 36 and 39.6 percent tation on itemized deductions (named for on their dividends as ordinary income.
bracket structure—is highly unlikely from a the member of Congress who sponsored
political and economic standpoint. the legislation). Alternatively, President IMPACT. For dividends, the increase
Obama has proposed replacement of the in tax rate for higher-income taxpayers
IMPACT. Under President Obama’s pro- PEP and Pease Limitation with a limit represents almost a 300 percent increase
posal, the 36 and 39.6-percent rates would on the value of itemized deductions for when a top 39.6 percent rate is combined
start at a higher-income bracket level of higher-income taxpayers. The President with the new 3.8 percent Medicare con-
$200,000 for single filers, $250,000 for would limit the value of otherwise allow- tributions tax on net investment income
joint filers, $225,000 for head-of-house- able deductions to 28 percent of AGI for (NII). Combined with a jump in the
holds, and $125,000 for married taxpay- those in his proposed 36 and 39.6 percent capital gains rate from 15 percent to 20
ers filing separately. Since these thresholds tax brackets. percent (23.8 percent with the NII tax),
were initially proposed in 2009, they some economists are predicting a massive
would also be indexed for inflation. Also During the campaign, the President said market sell-off at year end as taxpayers
they would be keyed to adjusted gross in- he saw no way to accommodate Governor engage in basis-resetting strategies and
come (AGI) rather than taxable income. Mitt Romney’s plan to reduce the individ- reallocation of portfolio assets. To cre-
Indexed 2013 projections for those AGI ual income tax rates by 20 percent across ate a softer landing, one proposal would
levels, based on the Administration’s FY the board in exchange for a reduction in the raise rates for taxpayers only with incomes
2013 Budget, are $213,200 / $266,500 number of deductions and loopholes cur- above $1 million, at least for the 2013
/ $239,850 / and $133,250, respectively. rently available. Obama maintained that he period until a more permanent structure
would not support a proposal in which “the under the umbrella of tax reform could
For a married couple filing a joint return, numbers don’t add up.” be enacted.
the tax brackets under President Obama’s
plan would be: COMMENT. The IRS has delayed issu- COMMENT. Under current law, taxpay-
ing some 2013 inflation adjustments, in- ers in the 10 and 15 percent income tax
Tax Rate 2013 Taxable Income cluding those affecting tax rate brackets, brackets pay zero percent tax on qualified
10% $0–$17,850 pending action by Congress. The IRS is capital gains and dividends.
15% $17,850–$72,500* expected to move quickly to release these
inflation adjusted amounts as soon as leg-
25% $72,500–$146,400
islation is passed by Congress and signed
Alternative Minimum Tax
28% $146,400–$223,050
by the President. If the alternative minimum tax (AMT) ex-
33% $223,050–$266,400 emption amounts are not patched for 2012,
36% $266,400–$398,350 they would be dramatically less than the ex-
Capital Gains/Dividends emption amounts for 2011. Under current
39.6% $398,350+
President Obama campaigned on allowing law, the AMT exemption amounts for 2012
* Also assumes continuation of marriage
penalty relief the Bush-era tax cuts—including the re- are $33,750 for single individuals, $45,000
duced capital gains and dividend tax rates— for married couples filing joint returns and
For a single individual, the tax rates under to expire for higher income individuals, and surviving spouses, and $22,500 for mar-
President Obama’s plan would be: he is not expected to change his position ried couples filing separate returns. In com-
now. Under the President’s proposal, the parison, the AMT exemption amounts for
Tax Rate 2013 Taxable Income current zero and 15 percent capital gains 2011 were $48,450 for single individuals,
10% $0–$8,925 and dividend tax rates would be extended $74,450 for married couples filing joint re-
15% $8,925–$36,250 after 2012 for single individuals with in- turns and surviving spouses, and $37,225
25% $36,250–$87,850 comes below $200,000 and families with for married couples filing separate returns.
incomes below $250,000.
28% $87,850–$183,250
In early 2012, President Obama proposed
33% $183,250–$213,200 The President’s proposal would increase replacing at least a portion of the AMT with
36% $213,200–$398,350 the tax rate on qualified capital gains to 20 the so-called “Buffett Rule,” essentially the
39.6% $398,350+ percent for single individuals with incomes principle that millionaire taxpayers should
CCH Tax Briefing
5. November 8, 2012
5
broaden the tax base. However, because there 2013 appears possible. Earlier this year, IMPACT. Before his re-election President
is consensus that a reduction in corporate in- the Senate approved legislation to provide Obama called for extension of the higher
come tax rates would be good for business for a Code Sec. 179 maximum dollar education tuition deduction, AMT relief
and good for the country, Congress is expect- amount of $250,000 and an $800,000 (the AMT “patch”), the enhanced Work
ed to enact corporate tax reform, although it investment limitation for tax years be- Opportunity Tax Credit (WOTC) for
may take until late 2013 or 2014 to do so. ginning after December 31, 2012. The veterans, and the production tax credit
House approved legislation to extend the for wind energy projects, among other
Code Sec. 179 small business expens- extenders. Now that he has been re-elect-
Corporate Tax Rate ing parameters originally put in place ed, there is nothing to indicate that the
President Obama has said that any cut in in 2003 ($100,000 and $400,000, re- President will withdraw his support for
the corporate tax rate must be revenue neu- spectively) through 2013. These amounts extending these provisions. The question
tral. That means certain business tax prefer- would be indexed for inflation for 2013, is: will lawmakers go along with the Pres-
ences are likely to be eliminated in exchange which the House GOP estimated at ident’s proposals and when will they act?
for the reduction. President Obama has $127,000 and $510,000, respectively.
repeatedly urged elimination of tax prefer- Disincentives to passing an expensing ex- IMPACT. Democrats and Republicans
ences for oil and gas producers, which could tension include its cost and what offsets generally agree that the longer they wait
be used to partly offset the cost of a corpo- may be used. to extend some or all of the extenders,
rate tax cut. the greater the likelihood of a delayed
2013 filing season. The IRS is preparing
COMMENT. In early 2012, President
Bonus Depreciation to process 2012 returns under the tax
Obama unveiled a Framework for Busi- Bonus depreciation at its current 50 percent law as it now reads. The IRS will need
ness Tax Reform in which he proposed rate is scheduled to expire after 2012 (after time to adjust its processing systems for
reducing the maximum corporate tax 2013 for certain transportation property late legislation.
rate from 35 percent to 28 percent, with and longer-lived property). It is unclear if
a reduced effective rate of 25 percent for President Obama will support an extension COMMENT. In past years, the tax extend-
qualified manufacturers. of 50 percent bonus depreciation. ers were routinely approved by Congress,
either at year-end or early in the subse-
COMMENT. Any discussions for a grand quent year and made retroactive. This
bargain could include moving the U.S. TAX EXTENDERS year may be different. Some lawmakers
from a worldwide system of taxation to have balked at the estimated $200 bil-
a territorial system of taxation, but this Linked to the Bush-era tax cuts are a pack- lion cost over 10 years of extending all of
is unlikely to be a priority. On the other age of so-called tax extenders. These are these tax benefits. However, it is unclear
hand, proposals made by the President popular but temporary tax incentives. which extenders, if any, would be allowed
in early 2012 to reward employers that Many of the tax extenders were effective to expire. In August, the Senate Finance
move operations from overseas plants to only through 2011 but may be retroactively Committee (SFC) approved the Middle
the U.S. with a tax credit could be re- extended for the entire 2012 tax year by the Class Tax Relief Act of 2012, which did
vived. President Obama also proposed to lame-duck Congress. Others were extended not renew some of the tax extenders (such
give employers that increase payrolls a tax through 2012. as brownfields remediation expensing and
credit. This proposal also could be revived
in year-end negotiations.
Small Business Expensing
SOME TAXES GOING UP?
Enhanced Code Sec. 179 expensing is sched- During his campaign, President Obama noted that it would be impossible for the
uled to expire after 2012. Unless extended, government to reduce its deficit without bringing in additional revenue and that ad-
the current expensing amount of $139,000 ditional taxes are necessary:
(as indexed for inflation) is scheduled to fall
to $25,000 and the current $560,000 in- “We’ve identified tax rates going up to the Clinton [pre-2001] rates for income above
vestment limit (as indexed for inflation) is $250,000; making some adjustments in terms of the corporate tax side that could
scheduled to fall to $125,000. actually bring down the corporate tax overall, but broaden the base and close some
loopholes. That would be good for our economy, and it would be good for reducing
COMMENT. Some compromise over ex- our deficit.”
tending expensing at a higher level into
CCH Tax Briefing
7. November 8, 2012
7
IMPACT. The AOTC applies to 100 per- New tax on medical devices (2013) agencies responsible for implementing
cent of the first $2,000 of qualified tu- State health insurance exchanges (2014) the Affordable Care Act.
ition and related expenses and 25 percent Individual shared responsibility pay-
of the next $2,000, for a total maximum ments (the individual mandate) (2014) COMMENT. The U.S. Supreme Court
credit of $2,500 per eligible student. Ad- Employer shared responsibility pay- upheld the Affordable Care Act’s indi-
ditionally, the AOTC applies to the first ments (2014) vidual insurance mandate in NFIB v. Se-
four years of a student’s post-secondary ed- Premium assistance tax credit (2014) belius, 2012-2 ustc ¶50,573. However,
ucation. The AOTC also allows for par- No annual dollar limits on health insur- opponents argue that the employer’s shared
tial refundability for qualified taxpayers. ance coverage (2014) responsibility payment was not addressed
Increase in small employer health insur- by the Court in NFIB v. Sebelius. Some
COMMENT. If the AOTC expires, it will ance tax credit (2014) taxpayers have also challenged the Afford-
be replaced by the traditional HOPE New tax on “Cadillac” health insurance able Care Act’s contraceptive provisions.
education tax credit. plans (2018)
Medicare Contribution Tax
Coverdell ESAs The Affordable Care Act imposes a 3.8 per-
After 2012, the $2,000 annual contribution
“President Obama cent Medicare contribution tax on the un-
amount for Coverdell education savings ac- campaigned on a promise earned income of higher-income individuals,
counts (Coverdell ESAs) is scheduled to revert to estates and trusts effective January 1, 2013.
$500. At the same time, the expanded definition
to extend the Bush- The Medicare contribution tax applies to net
of qualified education expenses for elementary era tax cuts for lower investment income (NII), and will gener-
and secondary school would also expire. ally apply to passive income. The Medicare
and moderate income contribution tax also applies to capital gains
Student loan interest deduction
individuals, but to allow from the disposition of property. For indi-
viduals, the Medicare contribution tax will
Under current law, certain enhancements to
them to expire for higher- apply to the lesser of the taxpayer’s NII or
the student loan interest deduction are sched- income individuals. The the amount of “modified” adjusted gross
uled to expire after 2012. If not extended, income (AGI with foreign income added
the incentive would only be available for the
President is not expected back) above a specified threshold.
first 60 months after repayment begins and to change his position
would phase-out for taxpayers with adjusted IMPACT. The modified AGI thresholds
gross income between $40,000 and $55,000
after the election, but for individuals are $250,000 for mar-
($60,000 and $75,000 for married couples fil- there could be some ried taxpayers filing jointly and surviv-
ing joint returns). ing spouses; $125,000 for married tax-
compromises on the payers filing separately; and $200,000
income thresholds that for single taxpayers and heads of house-
HEALTH CARE trigger the higher rates.” hold. These threshold amounts are not
indexed for inflation.
President Obama’s second term is expected to
see the continuing implementation of the Pa- IMPACT. The Medicare contribution tax
tient Protection and Affordable Care Act (Af- COMMENT. In 2012, the GOP-con- is not applicable to income derived from a
fordable Care Act). Many tax-related provi- trolled House attempted to repeal all trade or business, or from the sale of prop-
sions in the Affordable Care Act are scheduled or parts of the Affordable Care Act, erty used in a trade or business.
to take effect in 2013 and beyond, including: but the bills died in the Democratic-
controlled Senate. It is unclear if this NII for purposes of the Medicare contribu-
3.8 percent Medicare contribution tax pattern will be repeated in 2013. The tion tax includes gross income from inter-
(2013) House GOP has strongly signaled its est, dividends, annuities, royalties, and rents,
0.9 percent additional Medicare tax opposition to the IRS’s proposed regula- provided this income is not derived in the
(2013) tions on the Code Sec. 36B premium ordinary course of an active trade or busi-
$2,500 contribution limit on health assistance tax credit and is likely to ness; gross income from a trade or business
flexible spending accounts (2013) continue to oppose them. The GOP- that is a passive activity (within the mean-
Increased threshold for itemized medi- controlled House may also try to reduce ing of Code Sec. 469); gross income from
cal expenses (2013) funding to the IRS and other federal a trade or business of trading in financial
CCH Tax Briefing
9. November 8, 2012
9
ing that the Simpson-Bowles plan be giv- IMPACT. Some tax expenditures, such as Businesses. Many business tax expendi-
en a second look, to serve as a base from the child tax credit, the earned income tures would also be eliminated under the
which both Democrats and Republicans tax credit (EIC), the deduction for chari- Simpson-Bowles plan and similar plans
can find common ground. table contributions, and the deduction that aim to reduce the corporate tax rate.
for home mortgage interest, would likely The Simpson-Bowles plan projects a top
Six goals. The Simpson-Bowles plan has six survive tax reform, many observers ad- corporate tax rate of between 26 percent
goals: mit. However, retaining these incentives, and 29 percent, contingent upon elimina-
or any others, would need to be offset by tion of business tax expenditures.
Achieve nearly $4 trillion in deficit re- higher individual income tax rates.
duction through 2020; COMMENT. The Simpson-Bowles plan
Reduce the federal deficit to 2.3 percent IMPACT. Flow-through of business income specifies only a handful of business tax ex-
of gross domestic product (GDP) by to the individual tax returns of sole own- penditures for elimination. These include
2015 (2.4 percent excluding the plan’s ers, individual partners and S corporation the Code Sec. 199 domestic production
Social Security reform); shareholders creates a coordination problem activities deduction, and the Last In/ First
Reduce income tax rates, abolish the al- in trying to align individual tax rates with Out (LIFO) method of accounting. The
ternative minimum tax (AMT), and cut proposed changes under corporate tax re- Obama Administration, in contrast, has
“backdoor spending” in the Tax Code; form. Tackling both individual and corpo- made Code Sec 199 a centerpiece in pro-
Cap federal revenue at 21 percent of rate tax reform at the same time, however, viding a 25 percent effective tax rate for
GDP and get federal spending below 22 may prove to be too large an undertaking. manufacturers under its corporate reform
percent, and eventually to 21 percent; Treasury officials in the Obama Adminis- proposal issued in February 2012. The
Ensure lasting Social Security solvency; tration have appeared to favor concentrat- Administration’s FY 2012 Revenue Propos-
Stabilize the national debt by 2014, and ing on corporate tax reform first. als (the “Green Book”), on the other hand,
reduce it to 60 percent of GDP by 2023 recommends repealing the LIFO method of
and 40 percent of GDP by 2035. Capital gains/dividends. Under the Simp- accounting for inventories, a proposal that
son-Bowles plan, all capital gains and divi- has been opposed by certain industry groups.
Individuals. Various proposed tax reform dends would be taxed at ordinary income
plans would eliminate many income tax rates (which will have been lowered by the Territorial system. The Simpson-Bowles
expenditures, simplify others and use the elimination of tax expenditures). The plan plan would gradually move the U.S from a
revenue to lower the individual income tax notes that the effective tax rate on invest- worldwide system of taxation to a territo-
rates. The Simpson-Bowles plan projected ment income could be reduced by excluding rial system of taxation. Under a territorial
that elimination of all deductions and cred- a portion of capital gains and dividends (for system, income earned by foreign subsidiar-
its would achieve a bottom individual tax example, 20 percent) from income. Howev- ies and branch operations would be exempt
rate of eight percent, a middle individual er, to offset this exclusion while maintaining from U.S. taxation. The taxation of passive
tax rate of 14 percent and a top individual progressivity, the top tax rate on ordinary foreign-source income, however, would re-
tax rate of 26 percent. income would have to be increased. main unchanged.
CCH Tax Briefing