President Obama rolled out an ambitious new tax platform in his State of the Union address on Jan. 20. The new proposals would increase taxes on investment income and high-income earners to pay for new incentives for low-income taxpayers but widen the gap between the president and the Republican Congress.
The proposals stand little chance of enactment, with Republicans controlling Congress, and may establish taxation as a campaign issue for 2016 rather than an item of potential compromise. In the past, the president has cited business or corporate tax reform as an area in which he expected to be able to work with Republicans. However, he did not discuss tax reform as an area of compromise. Instead, he criticized lobbyists for rigging the tax code and called for closing loopholes to help lower-income Americans. By including tax increases that will be unacceptable to the Republican Congress in his new platform, the president has made enactment of tax reform over the next two years more difficult.
Some of the president’s new tax platform is recycled from earlier initiatives, but there are several new proposals. The revenue-raising provisions would generate approximately $320 billion by doing the following:
Raising the top rates on dividends and capital gains from 20% to 28%
Repealing the step-up in basis for inherited assets and requiring the gain to be immediately included in income
Creating a new fee equal to 7 basis points of the liabilities of financial institutions with more than $50 billion in assets
Repealing the student loan interest deduction
Repealing enhancements to Section 529 education savings plans
Limiting contributions and tax benefits to individual retirement accounts (IRAs) and other tax-deferred retirement plans once accounts exceed certain thresholds
The revenue raisers would generally be used to pay for incentives for lower-income taxpayers. Some of the most significant provisions would do the following:
- Create a new $500 credit for families in which both spouses work
Double the earned income tax credit (EITC) for taxpayers without children
Triple the child and dependent care credit for children under five
Enhance and make permanent the American Opportunity Tax Credit (AOTC)
Require employers with 10 or more employees to auto-enroll employees in an IRA
Increase credits for offering retirement plans or auto-IRAs to employees
Make student loan forgiveness exempt from income
The new tax platform was immediately dismissed by congressional Republicans, with Senate Finance Committee Chair Orrin Hatch, R-Utah, likening it to “class warfare.” With Republicans controlling Congress for the next two years, the chances for enactment for most of the provisions appears remote.
Perhaps more importantly, the new platform signals a deepening divide over tax reform between Republicans and the administration. The president has generally been cool to the idea of comprehensive tax reform that lowered individual rates, but has sought common ground with Republicans over “business reform.” Republicans have generally maintained that reform must also address pass-through businesses whose income is taxed at the individual level, but have cautiously remained open to possible compromise on business reform.
Senate Majority Leader Mitch McConnell, R-Ky., said he was disappointed the president didn’t mention tax reform and said he hoped the tax proposals were only “rhetoric,” because the president should know “we’re not likely to pass these kinds of measures.” It’s possible the president’s new platform may be partly aimed at discouraging Republicans from pursuing individual reform so they can focus only on business or corporate tax reform. Treasury Secretary Jacob Lew did make a strong pitch for business tax reform in a speech the day after the State of the Union address. Hatch has also recently said he is committed to marking up a bipartisan bill in committee, but it is increasingly hard to see how the administration and Republicans can find much common ground.
Full details are not available on all the administration’s proposals, because the platform was laid out in a short fact sheet. The following provides more information on what the president has released.
Capital gains and dividends
The American Taxpayer Relief Act of 2012, enacted in early 2013, raised the top rate on qualified dividends and long-term capital gains from 15% to 20% for taxpayers in the highest tax bracket. These highest tax brackets start at the taxable income thresholds of $413,200 for singles and $464,800 for joint filers in 2015. The president’s new proposal would raise the 20% rate to 28%, which does not include the additional 3.8% tax on net investment income under Section 1411.
Repealing the step-up in basis
Taxpayers inheriting assets at death generally receive a step-up or -down in the basis of the assets to their fair market value at the time of death. The president is proposing not only to eliminate this step-up in basis, but to require taxpayers inheriting the assets to pay tax on the gain immediately, whether they sell the assets or not. The provision would also apply to gifts.
Tangible personal property (except for collectibles and art) would be exempt, as would gifts and inheritances to spouses. The provision would include a portable general exemption of $100,000 and personal residence exemption of $250,000, allowing a surviving spouse to claim double the nominal exemption amount. Interests in small, family-owned and -operated businesses would not receive a step-up in basis, but owners would not realize gain until the business was sold. Closely held business would have the option of paying tax over 15 years.
However, the president’s basic outline of the tax plan does not elaborate on whether taxpayers inheriting assets whose fair market value is lower than its basis would immediately recognize a loss.
Financial crisis responsibility fee
The president recycled a proposal from previous budgets that would apply a fee to the liabilities of financial institutions with more than $50 billion in assets. The fee is reduced to 7 basis points from the 17 points originally proposed in the budget, but would apply more broadly, to asset managers and insurance companies.
The president is proposing to consolidate education incentives by repealing the lifetime learning credit, the recent enhancements for Section 529 plans and the deduction for student loan interest. In their place, the president would make permanent and enhance the AOTC. The AOTC generally provides a credit of up to $2,500 toward tuition and qualified expenses for the first four years of college. Up to $1,000 is refundable, but the provision is set to expire in 2017.
The president is proposing to make up to $1,500 refundable, extend the AOTC permanently and allow it to be claimed for up to five years by students going to school less than half-time. The president also proposed making student loan debt forgiveness exempt from tax.
The president proposed a new cap on IRAs in favor of increased incentives elsewhere. The fact sheet offers few details on the cap, but the administration appears to be recycling an earlier proposal to bar new contributions to an IRA once the value of the IRA balance exceeds the amount required to fund the maximum annuity allowed for a defined benefit plan, currently $210,000. The administration indicated the threshold required to fund such an annuity is currently equivalent to $3.2 million.
Every employer with at least 10 employees that does not offer its own plan would be required to automatically enroll employees into a new auto-IRA. Various tax credits would be offered to incentivize employer plans and the auto-IRA program. The administration would also require employers to offer their retirement plans to any employee who worked for at least 500 hours per year in any three years.
Family and work incentives
The platform proposes to double the child and dependent care credit to 50% of expenses up to $6,000 for children under five. It would also raise the income phaseout threshold. Flexible spending accounts for dependent care would be repealed.
In addition, the president proposes making permanent the EITC and child tax credit enhancements scheduled to expire at the end of 2016. The EITC would be further increased for taxpayers without children. The president also proposed for the first time a 5% credit of up to $500 against wages of a second working spouse. The credit would phase out from the joint income levels of $120,000 to $210,000.
The president has previously said that short-term revenues from tax reform could be used to pay for infrastructure spending but has now also proposed a new type of tax-preferred bond as part of his infrastructure agenda. The new Qualified Public Infrastructure Bonds would be similar to Private Activity Bonds but without the $15 billion cap. The bonds would generally allow public-private partnerships to access low rates and federal tax benefits of municipal bonds.
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