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Obama’s Minimum Tax on Millionaires May Conflict with AMT

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January 26, 2012

President Obama stuck to his main priorities in his State of the Union address on Tuesday night, with just a few surprises in the way of tax reform.

“I don’t think those priorities are particularly new,” said Rick Bailine, principal in charge of McGladrey’s Washington National Tax Office, in an interview Wednesday. “The three priorities that he seemed to set out were fairness, jobs and energy. He did tie the notion of tax policy to helping follow through on each of those three priorities.”

With regard to Obama’s mention during his speech of the so-called “Buffett rule,” that millionaires should not pay less than 30 percent in taxes, Bailine said the “devil is in the details,” but he noted that it might conflict with the alternative minimum tax (see Obama Backs Tax Reforms in State of the Union).

Rick Bailine

“The alternative minimum tax in our Tax Code, which dates back I believe to the early 1980s, has a focus not unlike what the President mentioned last night: to make sure that higher-net-worth individuals don’t have so many deductions that they can minimize or escape taxation,” he pointed out. “Right now, that alternative minimum tax is one of the biggest problems that Congress faces because it is hitting the middle class, which it was never designed to do. But through a confluence of events, not the least of which is simply inflation over the years, middle-class America is now being subject to that alternative minimum tax, and it’s a very big problem for Congress to solve.”

Bailine believes Obama will need to explain in greater detail than he did during his speech precisely what he meant, because the minimum tax he is proposing could, like the AMT, affect people it was never designed to impact. “Unless there’s some way to restrict that, I think he will have some issues in Congress,” said Bailine.

Congress has needed to “patch” the AMT nearly every year or two to prevent it from affecting millions more taxpayers in the middle class. The same problem could happen with Obama’s proposal, unless the legislation is carefully crafted.

“If you’re a small business owner and you’re looking to retire, and you sell your small business for $2 million, that means that in the year you sell your business, maybe you have income of $2 million,” said Bailine. “Normally you would think you would be subject to capital gains tax because you sold your business, which is the sale of a capital asset. But if under this proposal, in that one year you have this spike in income because you’ve sold your business, you now become a millionaire under this minimum tax of 30 percent.

“Small business owners who sell their business and show a big spike in income could be subject to this,” Bailine added. “Another one that Mr. Obama may not have thought about is: how about people who sell their homes? If you live in a major metropolitan area, it wouldn’t surprise anyone if your home is worth $1.2 million. If you sell the house, could you now be viewed as having a spike in income for one year? The sale of the house is subject to tax if you have a gain, but you can’t deduct the losses. There is already a partial exclusion for the sale of the house, but the question is, does the sale cause a spike in income where small business folks and homeowners could actually become subject to this tax inadvertently? And without the details, no one’s going to know the answers.”

Obama was also vague in his corporate tax reform proposals during his speech. The details of both Obama’s business and individual tax proposals will certainly be more fully fleshed out when the administration presents its budget request to Congress and the public. The Treasury Department typically publishes a “green book” after the budget comes out that describes the tax proposals with greater specificity.

Among the business tax proposals that Obama focused on during his speech were ones designed to encourage multinational corporations to bring outsourced jobs back to the United States.

“Obviously the President and the Congress both have a very strong interest in trying to promote tax legislation that would help create jobs in the United States,” said Bailine. “He actually proposed potentially a minimum tax on all multinational corporations that do business around the world, so that even though the bulk of your profits are from overseas, you would still pay some minimum level of tax in the United States. The President actually suggested earmarking the revenue that is raised by that corporate minimum tax to try to give tax incentives to organizations and corporations that create jobs in the United States. That sounds like a really good idea. I do think he would find bipartisan support for something like that, but again the problem may be how we do it.

“The current system of taxation, which is generally referred to as Subpart F of the Internal Revenue Code, for taxing the foreign subsidiaries of U.S. multinationals, is controversial and has been in the code for many, many years,” Bailine added. “Exactly how you address that in a way that can be found fair to all sides of businesses has been fairly controversial, so I do think that’s an area once again where he may run into some difficulty getting Congress to agree with him. Over the years, there’s been no agreement on how to address that issue.”

Obama’s energy proposals, including eliminating tax breaks to the major oil companies in favor of tax breaks to clean energy producers, could have a chance of getting passed, according to Bailine.

“That one may have legs,” he said. “He certainly put oil companies right on the bull’s eye of tax reform. He said we’ve been giving oil companies tax incentives for the better part of the last 100 years. He said those ought to be stopped and the same incentives ought to be provided to those who are creating alternative sources of energy, be it solar, geothermal, wind or whatever.”

In 2010, the energy bill that passed the House failed to get any traction in the Senate, in part due to fierce opposition to the cap-and-trade provisions. The bill was passed by the House, but then Democrats lost control in the November midterm elections and seemingly abandoned efforts to get a comprehsensive bill passed. The oil industry lobbied fiercely last year to protect its tax breaks when Obama pressed to eliminate them, but perhaps this will be the year when a bill gets passed. Any progress may ultimately depend on the election results in November.

Bailine thinks Congress might be willing to cut back on subsidies to the oil companies, but he noted that there are already many tax incentives in place for wind farms and other forms of green energy in the Tax Code. “I would think that is an area where he is more likely to find common ground in Congress,” he said. “We all realize that the United States needs a cohesive and comprehensive energy policy, and that’s something that both sides of the aisle seem to be willing to address.”

 

3 Comments

I view the millionaires tax as political rhetoric and little else. There are far too many complexities for such a tax to work. The biggest issue I see is the impact such a tax would have on the muni bond market if muni income is included. It would essentially neutralize the tax effectiveness of the bonds and drive yields and eventually rates to that of corporate bonds. If the bonds are excluded it will drive capital out of other forms of debt and into muni debt lower yields and rates while encouraging more local debt spending, which in the long run will just being adding more fuel to the fire.

The second biggest issue is that long term and short term trading would be treated the same. The government, financial experts and economists have all agreed that long term investing should be encouraged over short term, which is why there is a Pigovian tax on short term trading. The millionaires tax would substantially mitigate the tax differential and the desired Pigovian effect. There are also issues with driving foreign capital away and making it worthwhile to structure deals offshore in low tax countries.

What I dislike most in all this "tax the rich" rhetoric from the politicians is that it is deluding the public into believing that all we need to do is raise taxes on those with high incomes and the US's financial problems are fixed. You can run the numbers yourself using the IRS's historical data and within 10min learn that all these taxes will have a relatively small impact on the US's dire financial situation. When the Bush tax cuts expire this year, the Capital gains tax rate will rise to 20% and that is on par with the rate in nearly all of the major economic markets. In addition to that, taxes on dividends will return to ordinary income levels. That should be good enough, but as we know, we are now living in the political economy where reason and logic yields to destructive populist demands. There are no politically feasible solutions to the global debt problem, which means that as governments get desperate, we are going to see all sorts of bizarre tax policy as government seeks to tax those things that will have the least impact at the ballot box. Good for us accountants...I guess.

Posted by: FrankG | February 1, 2012 10:19 AM

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The original concept of a minimum tax took effect in 1970. The AMT as we now know it came into effect in 1982.

The tax reform act of 1986 set the tax rate on earned and unearned income the same. Taxpayers were not penalized for working for their income. When the original President Bush took office he convinced Congress that lowering the unearned income rate would spur investment and thus economic growth. Unfortunately, there is no historical data that indicates lowering the unearned tax rate spurs GDP growth. What historical data does indicate is that lowering the tax on unearned income creates more wealth for fewer people.

If the current administration is serious about fair taxation, then they should look at raising the unearned tax rate (not lowering it is suggested by the current crop of Republican candidates). Suggesting a 30% tax on millionaires would never pass Congress, and even if it did this article points out the pitfalls of such an approach.

Posted by: pendulumswings | January 31, 2012 9:27 AM

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This article addresses the real issues - the details will be the challenge. Unfortunately, President Obama to date has not demonstrated any interest in whether the sound bites of his speeches can come to an effective reality.

Posted by: dkstevenson | January 31, 2012 9:22 AM

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