Daily Tax Update - February 13, 2012: Obama Releases FY 2013 Budget

OBAMA RELEASES FY 2013 BUDGET:  Today, President Obama released the Fiscal Year 2013 budget, which proposes to cut the federal deficit by $4 trillion over the next ten years.  In his overview, the President said, "Together with the deficit reduction I signed into law this past year, this Budget will cut the deficit by $4 trillion over the next decade. This will put the country on a course to a level of deficits below 3 percent of GDP by the end of the decade, and will also allow us to stabilize the Federal debt relative to the size of the economy.  To get there, this Budget contains a number of steps to put us on a fiscally sustainable path."  Obama continued, "I believe that in our country, everyone must shoulder their fair share—especially those who have benefited the most from our economy.  In the United States of America, a teacher, a nurse, or a construction worker who earns $50,000 a year should not pay taxes at a higher rate than somebody making $50 million.  That is wrong.  It is wrong for Warren Buffett’s secretary to pay a higher tax rate than Warren Buffett.  This is not about class warfare; this is about the Nation’s welfare.  This is about making fair choices that benefit not just the people who have done fantastically well over the last few decades, but that also benefit the middle class, those fighting to get into the middle class, and the economy as a whole.  In the Budget, I reiterate my opposition to permanently extending the Bush tax cuts for families making more than $250,000 a year and my opposition to a more generous estate tax than we had in 2009 benefiting only the very largest estates.  These policies were unfair and unaffordable when they were passed, and they remain so today.  I will push for their expiration in the coming year.  I also propose to eliminate special tax breaks for oil and gas companies; preferred treatment for the purchase of corporate jets; tax rules that give a larger percentage deduction to the wealthiest two percent than to middle-class families for itemized deductions; and a loophole that allows some of the wealthiest money managers in the country to pay only 15 percent tax on the millions of dollars they earn.  And I support tax reform that observes the 'Buffett Rule' that no household making more than $1 million annually should pay a smaller share of its income taxes than middle-class families pay."

  • On the issue of tax reform, the budget states, "The country also faces the challenge of reforming the tax code to make it fairer and simpler and to provide sufficient revenue to meet long-run commitments.  Resolving the long-run fiscal challenge will require a comprehensive approach, one that restrains spending growth but also addresses the sufficiency of the tax code.  The 2013 Budget includes several proposed changes to the tax code that would close loopholes and eliminate tax breaks for special interests. It also calls on Congress to undertake comprehensive tax reform to both lower tax rates and generate new revenues."  The budget also states, "To begin the national conversation about tax reform the President is offering a detailed set of specific tax loophole closers and measures to broaden the tax base that, together with the expiration of the high-income tax cuts, would be more than sufficient to hit the $1.5 trillion target for tax reform, pay for tax cuts for the middle class, cut inefficient expenditures, and move the tax system closer to observing the Buffett Rule.  They also provide continued tax relief to millions of middle class families.  These proposals include eliminating the unwarranted and fiscally irresponsible Bush-era tax cuts for the highest-income families, limiting the value of tax deductions and preferences for the highest-income families, and closing a variety of tax loopholes.  The Budget proposals also would expand incentives for lower- and middle-income families to earn income, save for retirement, and attend college – activities that will strengthen the middle class and help to ensure that the United States remains a land of opportunity for all, not just for the most well off. . . . The Administration looks forward to working with the Congress and with other stakeholders to build on the foundation laid by this Budget to enact a tax system that is fair, simple, and efficient, on the foundation laid by this Budget to enact a tax system that is fair, simple, and efficient, one that is right for the 21st century American economy."  The budget adds, "The President is calling for fundamental tax reform and has offered five key principles – that reform should cut rates and simplify the system, reform tax loopholes and expenditures, cut the deficit, increase job creation and economic growth in the United States, and observe the Buffett rule.  As a down payment on reform, the President is offering a detailed set of proposals that would provide permanent tax cuts to working families, return to the pre- 2001 ordinary income tax rates for families making more than a quarter of a million dollars a year, close loopholes, and eliminate subsidies to special interests.  Extensions of certain expiring provisions and initiatives to promote program integrity are also proposed."
  • Highlights of the tax provisions in the FY 2013 budget include:
    • Extend temporary reduction in the Social Security payroll tax rate for employees and self-employed individuals.
    • Extend 100-percent first-year depreciation deduction for certain property—The Administration proposes to extend 100-percent first-year depreciation for one year, effective for qualified property acquired and placed in service before January 1, 2013 (January 1, 2014 for certain longer-lived and transportation property).  The Administration also proposes to continue the corporate election to claim additional AMT credits in lieu of the additional depreciation for property placed in service in 2012 regardless of prior-year elections of this provision.
    • Provide a temporary 10-percent tax credit for new jobs and wage increases—The Administration pro-poses to provide an income tax credit for employers for increases in wage expense, whether driven by job creation, increased wages or both.  The credit would be equal to 10 percent of the increase in the employer’s 2012 eligible wages over the prior year (2011).  The proposal would be effective for the one-year period beginning on January 1, 2012.
    • Provide additional tax credits for investment in qualified property used in a qualified advanced energy manufacturing project—The Administration proposes to provide an additional $5 billion in credits, thereby increasing the amount of credits certified by the Department of the Treasury to $7.3 billion.
  • Incentives for Expanding Manufacturing and Insourcing Jobs in America
    • Provide tax incentives for locating jobs and business activity in the United States and remove tax deductions for shipping jobs overseas—To provide a tax incentive for US companies to move jobs into the United States from offshore, the Administration proposes to create a credit against income tax equal to 20 percent of the expenses paid or incurred in connection with insourcing a US trade or business.  In addition, to reduce incentives for US companies to move jobs offshore, the proposal would disallow deductions for expenses paid or incurred in connection with outsourcing a US trade or business.  For this purpose, insourcing (outsourcing) a US trade or business means reducing or eliminating a trade or business or line of business currently conducted outside (inside) the United States and starting up, expanding, or otherwise moving the same trade or business within (outside) the United States.  Also for this purpose, expenses paid or incurred in connection with insourcing or outsourcing a US trade or business are limited solely to expenses associated with the relocation of the trade or business and do not include capital expenditures.
    • Provide new Manufacturing Communities tax credit—The Administration proposes to provide new tax credit authority to support qualified investments in communities affected by military base closures or mass layoffs, such as those arising from plant closures.  This would provide about $2 billion in credits for qualified investments approved in each of the three years, 2012 through 2014.
    • Target the domestic production activities deduction to domestic manufacturing activities and double the deduction for advanced manufacturing activities—The Administration proposes to limit the extent to which the deduction is allowed with respect to nonmanufacturing activities by excluding income derived from sources such as the production of oil and gas and the production of coal and other hard mineral fossil fuels from the qualified income on which the deduction is computed.  Additional revenue obtained from this retargeting would be used to increase the deduction rate for domestic manufacturing activity and to provide for an even greater deduction rate for activities involving the manufacture of certain advanced technology property.  The proposal would be effective for taxable years beginning after December 31, 2012.
    • Enhance and make permanent the research and experimentation (R&E) tax credit—A tax credit of 20 percent is provided for qualified research and experimentation expenditures above a base amount.  An alternative simplified credit of 14 percent is also provided.  These tax credits expired with respect to expenditures paid or incurred after December 31, 2011.  The Administration proposes to permanently extend these tax credits and to raise the rate of the alternative simplified credit to 17 percent.
  • Tax Relief For Small Businesses:
    • Eliminate capital gains taxation on investments in small business stock—The Administration proposes to permanently extend the 100-percent exclusion, extend the rollover period from 60 days to six months for stock held at least three years, and eliminate the AMT preference for the excluded gain.  Reporting requirements would be tightened to ensure compliance.  These proposals would be effective for qualified small business stock issued after December 31, 2011
    • Double the amount of expensed start-up expenditures—The Administration proposes to double permanently, from $5,000 to $10,000, the amount of start-up expenditures that a taxpayer may elect to deduct, effective for tax years ending on or after the date of enactment.  That amount would be reduced (but not below zero) by the amount by which the cumulative cost of start-up expenditures exceeds $60,000.
  • Continue Certain Expiring Provisions through Calendar Year 2013
    • A number of temporary tax provisions that have been routinely extended have expired or are scheduled to expire on or before December 31, 2012.  The Administration proposes to extend a number of these provisions through December 31, 2013.  For example, the optional deduction for State and local general sales taxes; the deduction for qualified out-of-pocket class room expenses; the deduction for qualified tuition and related expenses; Subpart F "active financing" and "look-through" exceptions; the modified recovery period for qualified leasehold, restaurant, and retail improvements; and several trade agreements would be extended through December 31, 2013.  Temporary incentives provided for the production of fossil fuels would be allowed to expire as scheduled under current law.
  • Upper-Income Tax Provisions
    • Sunset the Bush Tax Cuts for Those with Income in Excess of $250,000 ($200,000 if Single)
    • Reinstate the limitation on itemized deductions for upper-income taxpayers—Prior to the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Public Law 107-16, the deduction for otherwise allowable itemized deductions (other than medical expenses, investment interest, theft and casualty losses, and wagering losses) was reduced by three percent of AGI in excess of certain thresholds, but not by more than 80 percent of the otherwise allowable amount.  EGTRRA phased in the repeal of the limitation on itemized deductions over a five-year period, 2006 through 2010.  The repeal of the limitation on itemized deductions was extended for two years through 2012 under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  The Administration’s adjusted baseline assumes that the limitation on itemized deductions is permanently repealed.  The Administration proposes to reinstate the limitations on itemized deductions for married taxpayers filing joint returns with income over $250,000 (at 2009 levels) and for single taxpayers with income over $200,000 (at 2009 levels), effective for taxable years beginning after December 31, 2012.
    • Reinstate the personal exemption phaseout for upper-income taxpayers—The Administration’s adjusted baseline assumes that the phaseout of personal exemptions is permanently repealed.  The Administration proposes to reinstate the phaseout of personal exemptions for married taxpayers filing joint returns with income over $250,000 (at 2009 levels) and for single taxpayers with income over $200,000 (at 2009 levels), effective for taxable years beginning after December 31, 2012
    • Reinstate the 36-percent and 39.6-percent rates for upper-income taxpayers—The Administration proposes to replace part of the 33-percent tax rate bracket and all of the 35-percent tax rate bracket with the prior law tax rate brackets of 36 and 39.6 percent.  These rate increases would apply to married taxpayers filing a joint return with income over $250,000 (at 2009 levels) and to single taxpayers with income over $200,000 (at 2009 levels).
    • Tax qualified dividends as ordinary income for upper-income taxpayers—The Administration proposes to tax qualified dividends at ordinary income tax rates for married taxpayers filing a joint return with income over $250,000 (at 2009 levels) and for single taxpayers with income over $200,000 (at 2009 levels).  All other taxpayers would be taxed at the rates in effect in 2012.  The proposal would be effective for dividends received after December 31, 2012
    • Tax net long-term capital gains at a 20-percent rate for upper-income taxpayers—The Administration proposes to tax net capital gains at a 20-percent rate for married taxpayers filing a joint return with income over $250,000 (at 2009 levels) and for single taxpayers with income over $200,000 (at 2009 levels).  All other taxpayers would be taxed at the rates in effect in 2012.  The 18-percent capital gain rate on assets held over five years would be repealed, but special rates on gains from the recapture of depreciation on certain real estate, collectibles, and small business stock would be retained.  The proposal would be effective for capital gains realized after December 31, 2012.
  • Reduce the Value of Certain Tax Expenditures
    • Reduce the value of certain tax expenditures—The Administration proposes to limit the tax rate at which upper-income taxpayers can use itemized deductions and other tax preferences to reduce tax liability to a maximum of 28 percent.  This limitation would affect only married taxpayers filing a joint return with income adjusted for these tax preferences of over $250,000 (at 2009 levels) and single taxpayers with income over $200,000 (at 2009 levels).  The limit would apply to all itemized deductions, tax-exempt interest, employer-sponsored health insurance, deductions and income exclusions for employee retirement contributions, and certain above-the-line deductions, effective for taxable years beginning after December 31, 2012.
  • Modify Estate and Gift Tax Provisions
    • Restore the estate, gift, and GST tax parameters in effect in 2009—The Administration proposes to permanently extend estate, gift, and GST tax parameters as they applied for calendar year 2009.  Under those parameters, the estate of a decedent dying after December 31, 2012, would be taxed at a maximum tax rate of 45 percent with a life-time exclusion of $3.5 million.  Similarly, GSTs made after December 31, 2012, would be taxed at a maximum tax rate of 45 percent with a life-time exclusion of $3.5 million.  Gifts made after December 31, 2012, would be taxed at a maximum tax rate of 45 percent with a life-time exclusion of $1 million.  In addition, as reflected in the adjusted baseline, the portability of unused estate and gift exclusion amounts between spouses would be made permanent and would apply to decedents dying after December 31, 2012.
  • Reform US International Tax System
    • Defer deduction of interest expense related to deferred income of foreign subsidiaries—Under current law, a taxpayer that incurs interest expense properly allocable and apportioned to foreign-source income may be able to deduct that expense even if some or all of the foreign-source income is not subject to current US taxation.  To provide greater matching of the timing of interest expense deductions and recognition of associated income, the Administration proposes to defer the deduction of interest expense properly allocable and apportioned to stock of foreign subsidiaries to the extent the taxpayer’s share of the income of such subsidiaries is deferred.
    • Determine the foreign tax credit on a pooling basis—Under the Administration’s proposal, a taxpayer would be required to determine foreign tax credits from the receipt of income with respect to stock of a foreign subsidiary on a consolidated basis for all its foreign subsidiaries.  Foreign tax credits from the receipt of income with respect to stock of a foreign subsidiary would be based on the consolidated earnings and profits and foreign taxes of all the taxpayer’s foreign subsidiaries.
    • Tax currently excess returns associated with transfers of intangibles offshore—The IRS has broad authority to allocate income among commonly controlled businesses under section 482 of the Internal Revenue Code. Notwithstanding the transfer pricing rules, there is evidence of income shifting offshore, including through transfers of intangible rights to subsidiaries that bear little or no foreign income tax.  Under the Administration’s proposal, if a U.S parent transfers an intangible to a controlled foreign corporation (CFC) in circumstances that demonstrate excessive income shifting from the United States, then an amount equal to the excessive return would be treated as subpart F income.
    • Limit shifting of income through intangible property transfers—The Administration proposes to clarify the definition of intangible property for purposes of the special rules relating to transfers of intangibles by a US person to a foreign corporation (section 367(d) of the Internal Revenue Code) and the allocation of income and deductions among taxpayers (section 482) to prevent inappropriate shifting of income outside the United States.
    • Disallow the deduction for non-taxed reinsurance premiums paid to affiliates—Under the Administration’s proposal, a US insurance company would be denied a deduction for certain non-taxed reinsurance premiums paid to affiliates, offset by an exclusion for return premiums, ceding commissions, reinsurance recovered, or other amounts received from affiliates.
    • Limit earnings stripping by expatriated entities—Under the Administration’s proposal, the rules that limit the deductibility of interest paid to related persons subject to low or no US tax on that interest would be amended to prevent inverted companies from using foreign-related-party and certain guaranteed debt to reduce inappropriately the US tax on income earned from their US operations.
    • Modify tax rules for dual capacity taxpayers— The Administration proposes to tighten the foreign tax credit rules that apply to taxpayers that are subject to a foreign levy and that also receive (directly or indirectly) a specific economic benefit from the levying country (so-called "dual capacity" taxpayers).
    • Tax gain from the sale of a partnership interest on look-through basis—Under the Administration’s proposal, gain or loss from the sale of a partnership interest would be treated as effectively connected with the conduct of a trade or business in the United States and subject to US income taxation to the extent attributable to the partner’s share of the partnership’s unrealized gain or loss from property used in a trade or business in the United States.  The proposal would also require the purchaser of a partnership interest to withhold 10 percent of the purchase price to ensure the seller’s compliance.
    • Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment—To address concerns that taxpayers may repatriate offshore earnings through a related corporation and avoid current taxation, the Administration proposes to tax immediately a non-dividend distribution from a foreign corporation to the extent the distribution was funded by a related foreign corporation with a principal purpose of avoiding dividend treatment from distributions to a US shareholder.
    • Extend section 338(h)(16) of the Internal Revenue Code to certain asset acquisitions—Under section 338, taxpayers can elect to treat the acquisition of the stock of a corporation in a taxable transaction as an acquisition of the corporation’s assets for US tax purposes.  Because this election does not alter the foreign tax consequences of the transaction, section 338(h)(16) limits the ability of taxpayers to claim additional foreign tax credits by generally requiring the seller to continue to treat the gain recognized on the transaction as gain from the sale of stock for foreign tax credit purposes.  The Administration proposes to extend the rules limiting the ability of taxpayers to claim additional foreign tax credits as a result of a section 338 election to other similar transactions that are treated as asset acquisitions for US tax purposes but that are treated as acquisitions of an equity interest in an entity for foreign tax purposes.
    • Remove foreign taxes from a section 902 corporation’s foreign tax pool when earnings are eliminated—Under the Administration’s proposal, foreign income taxes paid by a foreign corporation would be reduced if a redemption transaction results in the elimination of earnings and profits of the foreign corporation.  The foreign income taxes reduced under the proposal would be the foreign income taxes that are associated with the eliminated earnings and profits.
  • Reform Treatment of Financial and Insurance Industry Institutions and Products
    • Impose a financial crisis responsibility fee—The Administration proposes to impose a fee on US-based bank holding companies, thrift holding companies, certain broker-dealers, as well as companies that control insured depositories and certain broker-dealers, with assets in excess of $50 billion.  US subsidiaries of international firms that fall into these categories with assets in excess of $50 billion would also be covered.  The fee would raise approximately $60 billion over ten years.
    • Require accrual of income on forward sale of corporate stock—A corporation generally does not recognize gain or loss on the issuance or repurchase of its own stock.  Thus, a corporation does not recognize gain or loss when it issues its stock in the future pursuant to a contract that entitles the corporation to receive a specified amount of consideration when the contract settles (typically referred to as a forward contract).  A corporation does, however, recognize interest income upon the current sale of any stock (including its own) for a payment to be received in the future.  The only difference between a corporate issuer’s current sale of its stock for deferred payment and an issuer’s forward sale of the same stock is the timing of the stock issuance.  In a current sale, the stock is issued at the inception of the transaction, whereas in a forward sale the stock is issued at the time the deferred payment is received. In both cases, a portion of the deferred payment economically compensates the corporation for the time value of deferring the payment. It is inappropriate to treat these two transactions differently.  The Administration proposes to require a corporation that enters into a forward contract to sell its own stock to treat a portion of the payment received when the stock is issued as a payment of interest. The proposal would be effective for forward contracts entered into after December 31, 2012.
    • Require ordinary treatment of income from day-to-day dealer activities for certain dealers of equity options and commodities—Under current law, certain dealers in securities, equity options, commodities, and commodities derivatives treat the income from section 1256 contracts entered into in their capacity as a dealer as generating 60 percent long-term capital gain (or loss) and 40 percent short-term capital gain (or loss). Dealers in other types of property uniformly treat the income generated by their dealer activities as ordinary income.  There is no reason to treat dealers in different types of property differently.  The Administration’s proposal would therefore require dealers in securities, equity options, commodities, and commodities derivatives to treat the income (or loss) from their dealer activities as ordinary in character.
    • Modify the definition of "control" for purposes of section 249 of the Internal Revenue Code—In gen-eral, if a corporation repurchases a debt instrument that is convertible into its stock, or into stock of a corporation in control of, or controlled by, the corporation, section 249 may disallow or limit the issuer’s deduction for any premium paid to repurchase the debt instrument.  For this purpose, "control" is determined by reference to section 368(c), which encompasses only direct relationships (e.g., a parent corporation and its wholly-owned, first tier subsidiary).  The definition of "control" in section 249 is narrow and has allowed the limitation in section 249 to be too easily avoided.  Indirect control relationships (e.g., a parent corporation and a second-tier subsidiary) present the same economic identity of interests as direct control relationships and should be treated in a similar manner.  The Administration proposes to amend the definition of "control" in section 249(b)(2) by referencing the definition of a controlled group in section 1563(a)(1), which includes indirect control relationships.
  • Other tax provisions include:
    • Repeal last-in, first-out (LIFO) method of accounting for inventories—Under the LIFO method of accounting for inventories, it is assumed that the cost of the items of inventory that are sold is equal to the cost of the items of inventory that were most recently purchased or produced.  The Administration proposes to repeal the use of the LIFO accounting method for Federal tax purposes, effective for taxable years beginning after December 31, 2013.  Assuming inventory costs rise over time, taxpayers required to change from the LIFO method under the proposal generally would experience a permanent reduction in their deductions for cost of goods sold and a corresponding increase in their annual taxable income as older, cheaper inventory is taken into account in computing taxable income.  Taxpayers required to change from the LIFO method also would be required to report their beginning-of-year inventory at its first-in, first-out (FIFO) value in the year of change, causing a one-time increase in taxable income that would be recognized ratably over ten years.
    • Repeal gain limitation for dividends received in reorganization exchanges—A limitation on recognition of gain for certain qualified corporate reorganizations (section 356(a)(1) of the Internal Revenue Code) can result in distributions of property with minimal US tax consequences.  The Administration proposes to repeal this limitation in reorganization transactions in which the acquiring corporation is either domestic or foreign and the shareholder’s exchange has the effect of the distribution of a dividend (within the meaning of section 356(a)(2)).  The proposal would be effective for taxable years beginning after December 31, 2012.
    • Tax carried (profits) interests as ordinary income—A partnership does not pay Federal income tax; instead, an item of income or loss of the partnership and associated character flows through to the partners who must include such items on their income tax returns. Certain partners receive partnership interests, typically interests in future profits, in exchange for services (commonly referred to as "profits interests" or "carried interests").  Current law taxes the recipient of a carried interest on the value at the time granted, which may be based on the value the partner would receive if the partnership were liquidated immediately (for example, the value of an interest only in future profits would be zero).  Because the partners, including partners who provide services, reflect their share of partnership items on their tax return in accordance with the character of the income at the partnership level, long-term capital gains and qualifying dividends attributable to carried interests may be taxed at a maximum 15-percent rate (the maximum tax rate on capital gains) rather than at ordinary income tax rates.  The Administration proposes to designate a carried interest in an investment partnership as an "investment services partnership interest" (ISPI) and to tax a partner’s share of income from an ISPI that is not attributable to invested capital as ordinary income, regardless of the character of the income at the partnership level. In addition, the partner would be required to pay self-employment taxes on such income, and the gain recognized on the sale of an ISPI that is not attributable to invested capital would generally be taxed as ordinary income, not as capital gain.  However, any allocation of income or gain attributable to invested capital on the part of the partner would be taxed as ordinary income or capital gain based on its character to the partnership and any gain realized on a sale of the interest attributable to such partner’s invested capital would be treated as capital gain or ordinary income as provided under current law.  The proposal would be effective for tax years ending after December 31, 2012.
  • Additional information can be accessed here and here.

TREASURY RELEASES "GREEN BOOK" OF ADMINISTRATION’S REVENUE PROPOSALS:  Today, the Treasury Department released the "General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals."

  • The document can be accessed here.

MISCELLANEOUS GUIDANCE RELEASED:

Revenue Procedure 2012-17, which provides rules describing when partnerships may provide K-1s electronically to partners. The partnership must receive the partner’s consent before providing K-1s electronically, instead of on paper. These new rules are similar to the rules governing the electronic furnishing of the 1099 and W-2s.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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