The Obama administration released its fiscal year 2017 budget containing a number of tax increases on high-income taxpayers, oil and foreign income, along with tax breaks for the middle class and small businesses, plus a provision giving the Treasury Department the explicit authority to regulate all paid tax preparers.
Among the changes proposed for reforming the international tax system, the budget plan would impose a 19-percent minimum tax on foreign income, impose a 14 percent one-time tax on previously untaxed foreign income, and limit the ability of domestic entities to expatriate.
The budget plan would also restrict deductions for excessive interest of members of financial reporting groups, provide tax incentives for locating jobs and business activity in the U.S. and remove tax deductions for shipping jobs overseas, limit shifting of income through intangible property transfers, and restrict the use of hybrid arrangements that create stateless income.
“We have seen a sustained economic recovery since President Obama took office seven years ago in the midst of the worst financial crisis since the Great Depression,” said Treasury Secretary Jacob J. Lew in a statement. “Nonetheless, we have much more work to do to ensure that the benefits of our growth are shared by all Americans. Today’s budget and Treasury’s Greenbook strive to address these and other pressing challenges our country faces through a series of tax proposals aimed at reforming the tax code, investing in infrastructure and protecting working families. These proposals would create the conditions for sustained economic growth while upholding the basic American belief that everyone who works hard should get a fair shot at success.”
The budget blueprint is not likely to go far in the Republican-dominated Congress, however. “President Obama will leave office having never proposed a budget that balances—ever,” said Speaker of the House Paul Ryan, R-Wis. “This isn’t even a budget so much as it is a progressive manual for growing the federal government at the expense of hardworking Americans. The president’s oil tax alone would raise the average cost of gasoline by 24 cents per gallon, while hurting jobs and a major sector of our economy. Americans deserve better. We need to tackle our fiscal problems before they tackle us. House Republicans are working on a balanced budget that grows our economy in order to secure a Confident America.”
Information Return Due Dates
One proposal would accelerate information return filing due dates. This proposal would accelerate the due date for filing for many information returns with the Internal Revenue Service, including Forms 1098 and 1099, from late February to January 31, the same day that the payee statements are due.
Tax Preparer Oversight and IRS Enforcement
Another proposal would increase oversight of paid tax return preparers. This proposal would explicitly provide that the Secretary of the Treasury has the authority to regulate all paid tax return preparers. This proposal would be effective as of the date of enactment.
Another budget proposal would increase funding for IRS enforcement through a program integrity cap adjustment. This proposal would adjust the discretionary spending limits for IRS tax enforcement, compliance, and related activities, including tax administration activities at the Alcohol and Tobacco Tax and Trade Bureau.
The proposed cap adjustment for fiscal year 2017 would fund $515 million in enforcement and compliance initiatives and investments above current levels of activity, allowing the IRS to continue to target international tax compliance and restore previously reduced enforcement levels. Beyond 2017, the Administration proposes further increases in new enforcement and compliance initiatives each fiscal year from 2018 through 2021 and to sustain all of the new initiatives and inflationary costs via cap adjustments through FY 2026.
IRS Whistleblower Program
To improve the IRS Whistleblower Program, this proposal would explicitly protect whistleblowers from retaliatory actions, consistent with the protections currently available to whistleblowers under the False Claims Act. In addition, the proposal would also provide that certain safeguarding requirements apply to whistleblowers and their legal representatives who receive tax return information in whistleblower administrative proceedings and extend the penalties for unauthorized inspections and disclosures of tax return information to whistleblowers and their legal representatives.
In the area of combatting tax-related identity theft, this proposal would provide that criminals who are convicted for tax-related identity theft may be subject to longer sentences than the sentences that apply to those criminals under current law.
In addition, the proposal would add a $5,000 civil penalty to the Tax Code to be imposed in tax identity theft cases on the individual who filed the fraudulent return. Under the proposal, the IRS would be able to immediately assess a separate civil penalty for each incidence of identity theft. There is no maximum penalty amount that may be imposed.
Family Tax Credits
One of the budget proposals would provide a new, simple tax credit to two-earner families. This proposal would provide a second earner tax credit of up to $500 per year to help cover the additional costs faced by families in which both spouses work. The proposal would benefit over 23 million low- and middle-income two-earner married couples.
To reform child care tax incentives, this proposal would repeal dependent care flexible spending accounts, increase the child and dependent care credit, and create a larger credit for taxpayers with children under age five. The income level at which the current-law credit begins to phase down would be increased from $15,000 to $120,000, so the rate reaches 20 percent at income above $148,000.
Taxpayers with young children could claim a child care credit of up to 50 percent of expenses up to $6,000 ($12,000 for two young children). The credit rate for the young child credit would phase down at a rate of one percentage point for every $2,000 (or part thereof) of adjusted gross income over $120,000 until the rate reaches 20 percent for taxpayers with incomes above $178,000. The expense limits and income at which the credit rates begin to phase down would be indexed for inflation for both young children and other dependents after 2017.
For workers without qualifying children, another budget proposal would expand the Earned Income Tax Credit for workers without children by doubling the maximum credit and expanding the range of eligible ages to cover workers between 21 and 67.
Education Tax Credits
To simplify and better target education tax benefits to improve college affordability, one proposal would consolidate the Lifetime Learning Credit and student loan interest deduction into an expanded AOTC, which would be available for the first five years of postsecondary education and for five tax years. In addition, this proposal would exclude all Pell Grants from gross income and the AOTC calculation, modify reporting of scholarships, repeal the student loan interest deduction, and provide a tax exclusion for certain debt relief and scholarships.
Tax Increases for Upper-Income Taxpayers
Other proposals would raise additional tax revenue by asking the wealthiest to pay more taxes. One proposal would limit the tax rate at which upper-income taxpayers could use itemized deductions and other tax preferences to reduce tax liability to a maximum of 28 percent. This limitation would reduce the value to 28 percent of the specified exclusions and deductions that would otherwise reduce taxable income in the top three individual income tax rate brackets of 33, 35, and 39.6 percent.
Another proposal would reform the taxation of capital income. This proposal would eliminate the capital gains step-up in basis at death with protections for the middle class, surviving spouses, small businesses and charities. Among other provisions, there would be a $100,000 per-person exclusion of other gains recognized at death. The proposal also raises the top tax rate on capital gains and qualified dividends from 20 percent to 24.2 percent, or 28 percent including the Net Investment Income Tax.
Building off of last year’s proposal to conform Self-Employment Contributions Act taxes for professional service businesses, this year’s proposal further closes loopholes in the SECA tax and the Net Investment Income Tax (NIIT). Under this proposal, all active business income would be subject to either the NIIT or Medicare payroll tax, so choice of business entity would not be a strategy for avoiding these taxes. All the revenues from the NIIT would be deposited in the Medicare Trust Fund.
This proposal would also rationalize the taxation of professional services businesses by treating individual owners or professional service businesses taxed as S corporations or partnerships as subject to SECA taxes in the same manner and to the same degree. This proposal would go into effect after December 31, 2016.
To implement the Buffett Rule, another proposal would impose a new “Fair Share Tax.” This budget proposal would ensure that high-income taxpayers could not use deductions and preferential tax rates on capital gains and dividends to pay a lower effective rate of tax than many middle-class families. The tax is intended to ensure that very high income families pay tax equivalent to no less than 30 percent of their income, adjusted for charitable donations.
Another proposal would restore the Estate, Gift, and Generation-Skipping Transfer (GST) tax parameters in effect in 2009. This proposal would make permanent the estate, GST, and gift tax parameters as they applied during 2009. The top tax rate would be 45 percent and the exclusion amount would be $3.5 million per person for estate and GST taxes, and $1 million for gift taxes. The proposal would be effective for the estates of decedents dying, and for transfers made, after Dec. 31, 2016.
Another proposal would modify the transfer tax rules for grantor retained annuity trusts and other grantor trusts. The proposal would make overly generous outcomes more difficult to achieve by requiring that donors leave assets in grantor retained annuity trusts (GRATs) for a fairly long period of time, prohibiting the grantor from engaging in a tax-free exchange of any asset held in the trust, and imposing other restrictions.
Other proposals would dramatically expand access to employer-based retirement savings options, including automatic IRA options for employees.
Still another proposal would permit unaffiliated employers to maintain a single Multiple Employer Defined Contribution Plan (MEP). Under current law, unaffiliated employers (firms not in the same line of business or without other common characteristics) cannot form a single defined contribution (401(k)) retirement plan. As a result, some smaller firms are unable to take advantage of the potential savings in administrative costs such a combination would allow. This proposal would permit unaffiliated employers to join a defined contribution MEP that would be treated as a single plan under the Employment Retirement Income Security Act (ERISA). This proposal would go into effect after December 31, 2016.
The budget also proposes to ease the excise tax on high cost employer-sponsored health coverage, also known as the Cadillac tax. Under current law for 2020 and later, the cost of employer-sponsored health coverage in excess of a threshold is subject to a 40-percent excise tax. The threshold is $10,200 for self-only coverage and $27,500 for other coverage in 2018 dollars, indexed to the Consumer Price Index for All Urban Consumers (CPI) plus one percentage point for 2019 and to the CPI thereafter.
To ensure that the tax is only ever applied to higher-cost plans, this proposal would increase the tax threshold to the greater of the current law threshold or a “gold plan average premium” that would be calculated for each state. This proposal would also simplify the accounting of employer and employee contributions to a flexible spending account.
Another proposal would tax carried interest profits as ordinary income. Current law provides that an item of income or loss of the partnership retains its character and flows through to the partners, regardless of whether the partners received their interests in the partnership in exchange for services.
Thus, some service partners in investment partnerships are able to pay a 20-percent long-term capital gains tax rate, rather than ordinary income tax rates on income items from the partnership. The Obama administration would tax as ordinary income a partner’s share of income on an “investment service partnership interest” (ISPI) 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.
Financial Firm Fee
To discourage excessive risk-taking by financial firms, under another budget proposal, large financial firms would pay an annual 7 basis point fee on their liabilities.
Another proposal would impose a fee on oil and oil products that would be equivalent to $10.25 per barrel of crude oil. The fee would be phased-in over a five-year period and would be collected on domestically produced as well as imported petroleum and imported petroleum products. Exported petroleum products would not be taxed and home heating oil would be temporarily exempt. Revenue from the fee would fund a 21st Century Clean Transportation Plan to upgrade the transportation system, invest in cleaner technologies, improve resilience, and reduce carbon emissions. In addition, 15 percent of the revenues would be dedicated for relief for households with particularly burdensome energy costs. Other fuel-related trust funds would be held harmless.
To limit the ability of U.S. companies to do tax inversions, one of the budget proposals would broaden the definition of an inversion under the law by reducing the 80-percent shareholder continuity threshold for domestic corporation status to a greater-than-50-percent threshold, and eliminate the 60-percent threshold. It would also provide that, regardless of the level of shareholder continuity, a transaction is an inversion if the fair market value of the stock of the domestic entity is greater than the fair market value of the stock of the foreign acquiring corporation, and if the affiliated group that includes the foreign acquiring corporation is primarily managed and controlled in the United States and does not have substantial business activities in the foreign country.
Multinational Tax Reforms
Another proposal aims to make the U.S. a more attractive location for businesses by creating a tax incentive to bring offshore jobs and investments back home, while reducing incentives to ship jobs overseas. The proposal would create a new general business credit against income tax equal to 20 percent of the eligible expenses paid or incurred in connection with insourcing a U.S. trade or business, and would disallow deductions for expenses paid or incurred in connection with outsourcing a U.S. trade or business.
To restrict the use of hybrid arrangements that create stateless income, another proposal would deny deductions for interest and royalty payments (which are generally deductible under current law) when such payments are made to related parties pursuant to transactions involving hybrid arrangements that result in income that is not subject to tax in any jurisdiction.
In addition, the proposal would eliminate exceptions under current law which lead to situations where shareholders are not subject to tax currently in either the United States or in the related firm’s foreign jurisdiction because an entity is considered a separate corporation under U.S. tax law and a pass-through entity in another jurisdiction. The proposal would require current U.S. taxation of such payments.
Small Business Expensing and Accounting
Another proposal would expand expensing for investments made by small businesses. The proposal would increase the maximum expensing limitation to $1 million and the phase-out threshold would remain at $2 million with both amounts being indexed for inflation. The proposal would become effective for property placed in service in 2017.
The budget plan would also expand a simplified accounting for small businesses and establish a uniform definition of small business for accounting methods. Beginning in 2017, small businesses —defined as those with less than $25 million in average annual gross receipts—would be exempted from certain accounting requirements, allowing them to use the cash method of accounting, avoid the uniform capitalization requirements for both inventory and produced property, and use an inventory method that either conforms to the taxpayer’s financial accounting method or is otherwise properly reflective of income. The gross receipts threshold would be indexed for inflation for taxable years beginning after Dec. 31, 2017.
The budget plan would also increase the limitations for deductible new business expenditures and consolidate provisions for start-up and organizational expenditures. A taxpayer is generally allowed to deduct up to $5,000 of start-up expenditures in the taxable year in which an active trade or business begins, and may deduct up to $5,000 of organizational expenditures in the taxable year in which a corporation or partnership begins business. In each case, the $5,000 amount would be reduced (but not below zero), by the amount by which such expenditures exceed $50,000. The proposal would consolidate these provisions, and would allow $20,000 of combined new business expenditures to be expensed, beginning in 2017. That immediately expensed amount would be reduced by the amount by which the combined new business expenditures exceed $120,000.
Another proposal would expand and simplify the tax credit provided to qualified small employers for non-elective contributions to employee health insurance. This proposal would expand the credit for small employers to provide health insurance for employees and their families to employers with up to 50 (rather than 25) full-time equivalent employees and would phase out the credit between 20 and 50, rather than between 10 and 25, full-time equivalent employees. A new phase-out methodology would benefit qualified smaller businesses by ensuring they were eligible for some amount of credit if they met the statutory constraints.
R&D Tax Credit
To enhance and simplify research and development tax incentives, another proposal would improve on the research and experimentation (R&E) tax credit that was recently made permanent using one of two allowable methods. Under the “traditional” method, the credit is 20 percent of qualified research expenses above a base amount related to the firm’s historical research intensity during the 1984 to 1988 period. Under the alternative simplified research credit (ASC), the credit would be 14 percent of qualified research expenses in excess of a base amount reflecting its research spending over the prior three years. This proposal would repeal the “traditional” method.
In addition, the proposal would increase the rate of the ASC from 14 percent to 18 percent, eliminate the reduced ASC rate of six percent for business without qualified research expenses in the prior three years, allow the credit to offset Alternative Minimum Tax liability, repeal a special rule for pass-thru entities that limited use of the credit, and allow 75 percent of payments to qualified non-profit organizations (such as universities) to be included as contract research (an increase from 65 percent).
Work Opportunity Tax Credit
Another proposal would extend and modify certain employment tax credits, including incentives for hiring veterans. This proposal would permanently extend the Work Opportunity Tax Credit (WOTC) to qualified individuals who begin work after Dec. 31, 2019. The Indian Employment Credit would be permanently extended to apply to qualified individuals who being work after Dec. 31, 2016.
Beginning in 2017, the Administration also proposes to expand the definition of disabled veterans eligible for the WOTC to include disabled veterans who use the GI bill to receive education or training starting within one year after discharge and who are hired within six months of leaving the program.
To provide a Community College Partnership Tax Credit, another proposal would provide businesses with a new tax credit for hiring graduates from community and technical colleges as an incentive to encourage employer engagement and investment in these education and training pathways. The proposal would provide $500 million in tax credit authority for each of the five years, 2017 through 2021. The tax credit authority would be allocated annually to states on a per capita basis and would be available to qualifying employers that hire qualifying community college graduates.
Renewable Energy Incentives
Another proposal would modify and permanently extend the renewable electricity production tax credit and the investment tax credit. This proposal would permanently extend the renewable electricity production tax credit, make it refundable, and make it available to otherwise eligible renewable electricity consumed directly by the producer rather than sold to an unrelated third party, provided this production can be independently verified. This proposal would also allow individuals to claim the production tax credit for electricity produced in connection with a residence, regardless of whether it is consumed on-site or sent back to the grid. Further, the proposal would permanently extend the renewable energy investment tax credit for businesses under the terms available in 2017. Specifically, the proposal would permanently extend the 30 percent investment tax credit for solar, fuel cell, and small wind property and the 10 percent credit for geothermal and other sources
To provide a Carbon Dioxide Investment and Sequestration Tax Credit, this proposal would provide $2 billion for a new, refundable allocable investment tax credit for carbon capture and storage property. In determining the award of the investment tax credit, the Treasury Secretary would consider (i) the credit per ton of net sequestration capability and (ii) the expected contribution of the technology and the type of plant to which that technology is applied to the long-run economic viability of carbon sequestration from fossil fuel combustion. The proposal would also provide a 20-year, indexed, refundable sequestration tax credit. The credit would be $50 per metric ton of carbon dioxide permanently sequestered and not beneficially reused (e.g., in enhanced oil recovery) and $10 per metric ton for carbon dioxide that is permanently sequestered and beneficially reused.
New Markets Tax Credit
Another proposal would modify and permanently extend the New Markets Tax Credit. The proposal would permit NMTCs resulting from qualified equity investments made after Dec. 31, 2019, to offset AMT liability, which is not currently allowed. This proposal would also permanently extend the NMTC and provide $5 billion of credit allocation authority per year. This proposal aims to create greater certainty for taxpayers and encourage additional capital investments in low-income communities.
Low-Income Housing Tax Credit
President Obama’s budget includes several proposals to reform and expand the Low-Income Housing Tax Credit (LIHTC), including allowing conversion of private activity bond (PAB) volume cap into LIHTCs. Under current law, each state is provided annually a statutorily determined amount of LIHTCs (the LIHTC ceiling) for the state to allocate to developers who want to construct or rehabilitate buildings for low-income residents.
Also, under current law, each state is provided annually a statutorily determined limit (volume cap) on the qualified PABs that the state may issue. If a building is at least half financed with PABs subject to the volume cap, the building may earn LIHTCs that are not subject to the state’s LIHTC ceiling but that are earned at a lower rate than the rate that generally applies to allocated LIHTCs, provided that all the qualifications are met.
A major part of the proposal is that it would allow each state annually to convert up to 18 percent of its PAB volume cap into an increase in its LIHTC ceiling. If a developer is awarded sufficient PAB volume cap to issue bonds that would qualify its building for LIHTCs but the developer does not need PAB financing, then the developer would be able to convert its volume cap into the amount of LIHTCs that it would have earned if it had issued the bonds and financed the building with them.
To build upon the successful temporary Build America Bond program under the American Recovery and Reinvestment Act of 2009, another proposal would create a new, expanded, and permanent America Fast Forward Bond (AFFB) program as an optional alternative to traditional tax-exempt bonds. AFFBs would be taxable bonds issued by state and local governments for which the federal government makes direct borrowing subsidy payments to those issuers (through refundable tax credits) at a subsidy rate equal to 28 percent of the coupon interest on the bonds. This subsidy rate is intended to be approximately revenue neutral relative to the estimated future federal tax expenditures for tax-exempt bonds. As an expansion of uses, AFFBs could be used for projects typically financed with qualified private activity bonds and qualified public infrastructure bonds in order to support a wide variety of public investments.
To facilitate public-private partnerships, another proposal would create a new category of tax-exempt qualified private activity bonds, called “Qualified Public Infrastructure Bonds” (QPIBs) to finance specified types of infrastructure projects. The projects must be owned by State or local governments and be available for general public use. Eligible types of projects would include airports, docks and wharves, mass commuting facilities, facilities for the furnishing of water, sewage facilities, solid waste disposal facilities, qualified highway or surface freight transfer facilities, and broadband telecommunications assets. The proposal would be effective for bonds issued starting Jan. 1, 2017.