By L. Michael Gracik, Jr., CPA, Managing Partner
Early this month, the President released his budget proposals for fiscal year 2016. There are a number of themes in the tax proposals:
- Tax increases for high income taxpayers
- Expansion of tax incentives for families
- Reduction in corporate tax rates coupled with repeal of a number of so-called “tax loopholes”
- New tax regime for corporations with foreign earnings
- Repeal of the LIFO inventory method
- Permanent enhancement of the Section 179 deduction
- Research Tax Credit made permanent
- Estate and gift tax rates and credits reinstated to 2009 amounts
- Increase in annual budgets for the IRS
It is highly unlikely that any of these proposals will be passed by the Republican led Congress. However, they will be a part of tax reform debate that could start in Congress later this year, as the Senate Finance Committee is expected to announce the results of a tax reform study in May, and the House is expected to hold hearings on tax reform as soon as this Spring. Adding to the debate could be a new battle over the “tax extenders” which were only extended through 2014 by the last Congress.
Let’s review some of the proposals in a little more detail.
INDIVIDUAL TAX PROVISIONS
- The top tax rate for capital gains and qualified dividends would be increased to 28% (24.2% plus the 3.8% NII tax ) beginning in 2016. For married couples, this rate would apply to annual incomes in excess of $500,000. In releasing the proposals, the administration stressed that 28% was the capital gain rate during some of the Reagan years.
- For higher income taxpayers, the President would limit the tax value of itemized deductions and other tax preferences, such as tax exempt interest, to 28%. A new minimum tax rate of 30% would apply to the income of those taxpayers; this is the “Buffett Rule” proposal.
- The maximum child and dependent care credit for families with children under age 5 would increase to $3000 per child.
- The budget includes a proposal for a new second earner tax credit of up to $500 for qualified couples where both spouses work.
- The American Opportunity Tax Credit would be made permanent and expanded. Several other education tax incentives would be consolidated into this credit, either by being repealed or allowed to expire including the lifetime learning credit and the higher education tuition deduction.
GENERAL BUSINESS TAX PROVISIONS
- The President’s budget would reduce the top corporate tax rate to 28% from its current 35% with a 25% top effective rate for corporations engaged in domestic manufacturing The rate reduction would be offset by the elimination of certain fossil fuel tax breaks and other unspecified business tax breaks.
- As mentioned above, the Research Credit would be made permanent under the proposals. In addition, the Work Opportunity Tax Credit (WOTC) would be made permanent with expanded definitions of eligibility for disabled veterans.
- The New Markets Tax Credit (NMTC) would be permanently extended with modifications.
SMALL BUSINESS TAX PROVISIONS
- The 2014 limit of $500,000 for expensing depreciable property would be extended through 2015. The maximum expensible amount would be increased to $1 million beginning in 2016 and would be indexed for inflation beginning in 2017, effectively making this provision permanent.
- Beginning in 2016, and indexed for inflation thereafter, small businesses would be defined as those with less than $25 million in average annual gross receipts. Under the proposals, small businesses, no matter how they are organized, would be exempt from the UNICAP rules and would be able to use the cash method of accounting.
- The budget proposals would permanently extend the 100 percent exclusion from tax by a non-corporate taxpayer on the sale of qualified small business stock issued after September 27, 2010 and held for more than 5 years. The amount of gain eligible for exclusion would be the greater of $10 million or 10 times the taxpayer’s basis in the stock. The excluded gain would also be excluded for the AMT.
- The deduction for organization and start-up expenses would be consolidated into one deduction and would allow a combined deduction of $20,000 beginning in 2016.
- The small business health insurance credit would be expanded to employers with up to 50 full time employees (FTE) employees rather than the 25 FTE limit under current law.
- Under the budget proposals, professional service firms organized as S corporations would no longer be able to avoid self employment taxes. All of the pass-through income to the owners of these types of businesses organized as S corporations would be subject to payroll or self-employment taxes.
ESTATE AND GIFT TAX PROVISION
- The budget proposal would make permanent, after 2015, the estate, GST, and gift tax parameters as they applied during 2009. The top estate tax rate would increase from 40% to 45%. The estate and GST exemption would be reduced to $3.5 million, and the gift tax exemption would be reduces to $1 million. The exemptions would not be indexed for inflation.
- The portability of a decedent’s unused exemption amounts by a surviving spouse would be preserved with a special rule that applies to the reduced exemption for lifetime gifts.
- The budget proposals include provisions that would change the way taxpayers calculate their tax basis on inherited property. Under a very complex proposal taxpayers would be required to pay capital gains taxes on the increase in the value of securities over the original tax basis at the time the securities are inherited.
- Substantial changes would be made to the tax rules governing grantor retained annuity trusts (GRATS), including a requirement for a minimum 10 year term. Any new GRATS would be required to have a minimum value for the remainder interest equal to 25% of the value of the assets contributed to the GRAT or $500,000 (but not more than the value of the assets contributed.)
- The proposals would eliminate the present interest requirement in order for gifts to qualify for the annual exclusion. However the total annual exclusion available for all gifts by a donor for this new class of gift, which would include most gifts to trust with withdrawal rights (so-called “Crummy” rights )would be limited to $50,000.
NOTE ON THE ESTATE AND GIFT TAX PROVISIONS: Since the current estate tax provisions were made “permanent” at the end of 2012, many taxpayers have not been active in their estate planning. Since the administration is once again targeting the current estate and gift tax rules, taxpayers should give thought to taking estate and gift tax steps to take advantage of our current favorable estate and gift tax system.
In addition to the above provisions, there are a number of proposals that would substantially reform the US International Tax system, including the imposition of a minimum 19% tax on foreign income of US multinationals and restrictions on the ability of multinational companies to use “inversion” transactions to reduce income subject to US taxation. These provisions are beyond the scope of this paper.
While it is highly unlikely that the entire package of the tax provisions contained in the President’s budget proposals will pass Congress, many of these provisions are appealing to House and Senate Republicans and could end up being part of a comprehensive tax reform package.
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Source: Treasury Department’s “ General Explanation of the Administration’s Fiscal Year 2016 Revenue Proposals”
As Managing Partner of Keiter, Mike oversees the Firm’s strategic plan and growth initiatives. Mike’s clients benefit from his 38 years of experience and tax insights. His client’s include closely-held businesses in the real estate, home building, manufacturing, construction, retail and wholesale industries. He also serves many estates, trusts and foundations. Read more of Mike’s insights on our blog.
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