President Obama’s State of the Union speech last week outlined a broad agenda of tax provisions that he hopes will breathe new life into the economy. The overall idea is familiar… take more from taxpayers at one end of the financial spectrum and distribute it to some at the other end, using a series a tax maneuvers. According to The Wall Street Journal, Obama’s $3.8 trillion budget for the next decade will collect an additional $2 trillion in taxes from targeted groups, and still leave us with a debt of over $8.5 trillion. The speech itself did not provide a lot of details, but in the days since, flesh is beginning to appear on the budget bones. Here are some highlights of Obama’s proposed changes:
Tax provisions affecting individuals:
Making Work Pay Credit. This would be a one year revival of the 2009 payroll credit designed to put $400 additional dollars in the hands of workers, by reducing payroll tax withholding. Obama says that last year, this credit provided $37 billion in relief to 110 million families
Extension of tax cuts for some. According to ABC News, Obama wants to make permanent the tax cuts of the Bush Administration for those earning a maximum of $200,000, and families earning $250,000 or less.
Removal of existing tax cuts for others. Obama has announced his intention to eliminate the Bush tax cuts for the group he refers to as “wealthy.” Currently, income tax rates affecting this group are 33% and 35%. Presumably, under Obama’s plan, the rates will rise to the pre-Bush levels of 36% and 39.6% respectively. The higher rates will apply to those earning more than $250,000. Lewis Taub, a director at RSM McGladrey’s Commercial Group, says that Obama likes to use the terms “wealthy” and “$250,000” equally. However, Taub indicated that the president has not yet defined $250,000 sufficiently for us to know if he is talking about taxable income, gross income, or adjusted gross income. The label “tax increases” is seldom used, but The Wall Street Journal reports that over the next decade, the elimination of the Bush tax cuts will be largely responsible for raising an additional $1 trillion in tax revenue.
Higher capital gains tax. The president also plans to raise capital gains and dividends tax from the current level of 15% up to 20%. Taub predicts that taxpayers with capital gain potential will be seeking a lot of help from their financial advisers before the end of this year. “This is a perfect planning time for clients,” he says. “When capital gains rates are going down, nobody wants to talk to us. Now they will need to do some serious planning.” Taub suggested that it's likely that accountants will be urging clients who are facing significant capital gains to take those gains in 2010, in advance of the tax hike.
Child and Dependent Care Tax Credit. This credit nearly doubles for middle-class families earning under $85,000 a year. It increases the maximum credit rate from 20 percent to 35 percent.
Education credit. Obama is proposing a $10,000 tax credit for those who complete four years of college. Student loan payments would not be allowed to exceed 10% of income and the debt is forgiven after 20 years, or 10 years if the individual takes a job in public service.
COBRA extension. Last year’s 65% reduction of health insurance premiums paid by employees who have lost their jobs could be extended. This provision also affects businesses of course, although the effect is meant to be one of timing because the business pays the health insurance at the 100% rate and later receives reimbursement from the government for the 65% reduction.
Tax provisions affecting business
Small business tax exemption. This is a boost for small publicly traded businesses, in the form of an expanded exclusion of gain from the sale of small business stock. Currently the exclusion is at 75%, and is set to expire at the end of 2010. Obama plans to replace it with a beefier, 100% exclusion.
Analysts say this should make investment in small business stock more attractive, especially when combined with Obama’s plan to raise the capital gains tax on other investments from the current rate of 15% up to 20%. If this becomes law, Taub expects to see more accountants advising clients to choose qualifying small business stock as a tax-favored investment. He predicts that, in the coming months, we will see certain limitations placed on this exclusion. For example, angel investors may have to hold onto the stock for a minimum of five years before selling. There also might be a limitation on the amount of gain that qualifies for the exclusions, Taub suggested, such as the greater of $10 million in gain or ten times the amount of your gain.
Depreciation. In an effort to encourage businesses to invest in plants and equipment, Obama’s budget extends two key depreciation tax breaks, both of which expired at the end of 2009. Before 12/31/09, Section 179 was at its highest level ever: $250,000 for plants and equipment placed in service during the year. For expenditures that exceeded that cap, most businesses also could qualify for the first year bonus deprecation, which allowed a write-off of 50% of the cost of new plants and equipment.
As of January 2010, the Section 179 deduction receded to $134,000, and the first year bonus deprecation disappeared. Obama’s budget would extend the life of both provisions at the 2009 levels.
But some critics have said that, while this could be a boost for businesses, many will have to wait until the economy improves before they can make qualifying purchases. Taub acknowledges the difficulties for businesses that are tight on cash, but sees this provision as a favorable move for business. “It’s a chicken and egg question. The administration is counting on the fact that the economy is already recovering.” He pointed out that at the end of 2009, when the provisions were about to expire, he and his colleagues were already pushing clients to take advantage of the depreciation tax breaks while they could. “Clients do seem to be thinking in terms of expansion already,” he said. “This will further encourage them to invest in expansion, which is tied to jobs.”
Giovanni Coratolo, the vice president of small business policy at the U.S. Chamber of Commerce, agrees that the depreciation provisions are good moves. He told reporters, ““They incentivize businesses to make their businesses more profitable.” They have a “leveraging effect,” he adds, because they also provide revenue for manufacturers of equipment.
Clint Stretch, managing principal for tax policy at Deloitte Tax stated, “Businesses planning for an upturn in the economy would be encouraged to start making the investments in equipment that will be part of getting going again and hiring workers back.”
New tax credit for hiring additional workers and for raising wages. Obama says this provision will help more than a million small businesses. So far, details of this plan have been skimpy. But, suggested Taub, Senator Robert Casey (D-PA) has proposed a similar bill which provides a 20% credit for new hires at companies that have less than 100 employees (Casey’s credit would only go to those who hire new employees).
One possibility, according to some sources, is that this could amount to a tax credit of up to $5,000 that employers could take against payroll taxes for every new hire in 2010. While all firms that hire additional workers would be eligible, limitations and anti-abuse provisions would be in place to ensure that the bulk of the incentive to hire is used by small businesses.
Coratolo doesn’t see a hiring credit as effective. He told reporters, “It’s nice to be able to get a tax break” if you were planning to hire anyway, but unless your company has enough work to keep additional employees occupied, a tax credit would not be enough incentive. Plus, he pointed out that the tax credit is temporary, and a job is meant to be long-term.
A survey taken by the National Small Business Association indicated that this credit would not have much effect on the decision to hire.
Provisions under the radar
According to Taub, the president’s budget addresses several other issues, called sleepers, that get very little press but that could significantly impact businesses.
One of these provisions is the treatment of leasehold improvements. Prior to 2007, leasehold improvements were depreciable over 39 years. For 2007- 2009, that period was reduced to a much more business-friendly 15 years. That provision expired at the end of 2009. Obama has stated his intention to extend the favorable shorter depreciation period.
The administration also proposed the total repeal of the use of the LIFO and the lower of cost or market methods of inventory valuation. “This was a much bigger deal during inflationary times,” said Taub, “when prices of raw materials were always going up.” Obama’s budget includes plans to let LIFO die and to disallow the use of lower of cost or market. “These are important provisions, but they are not getting much press right now because we are in deflationary times.”
One more sleeper provision that Taub is concerned about is the possibility of requiring corporations to receive 1099 forms for work performed. Currently, corporations are excluded from this requirement. While he doesn’t think this will become law because it is too complicated to be workable, Taub sees the idea as revealing. He believes it shows the mindset of the government right now is to find ways to squeeze every possible dollar from corporations.