As you undoubtedly have heard, "Taxmageddon" is quickly approaching – a convergence at year end of the expirations of the Bush tax cuts, various economic stimulus provisions and the payroll tax holiday as well as the imposition of new Medicare taxes as part of healthcare reform and another battle over the debt ceiling. All of this is coming during a stubbornly sluggish economy with massive mandatory spending cuts also looming on the horizon. With many predicting that Congress will temporarily extend many of the tax cuts to stave off disaster for another year, the tax policies of the next President may dictate how these issues are eventually resolved. Let's compare the platforms of the two Presidential candidates, both with respect to the expiring tax provisions and long-term tax reform.
Expiring Bush Tax Cuts
Several tax cuts passed under the Bush administration in 2001 and 2003 ("Bush tax cuts") originally were to expire at the end of 2010, the results of which would have sent tax rates higher and eliminated a host of favorable tax provisions in the middle of a recession. Fearing that a tax increase would damage an already fragile economy, Congress and President Obama temporarily extended the Bush tax cuts through 2012.
Some of the major tax provisions included in the Bush tax cuts include (not an exhaustive list):
- Lower individual tax rates,
- 15% capital gains and qualified dividends tax rates,
- Elimination of the phase-outs on itemized deductions and personal exemptions for upper-income taxpayers, and
- Marriage penalty relief.
The fate of the Bush tax cuts are once again on the line – this time in the middle of the Presidential election season. It is all but certain that the future of the Bush tax cuts will not be resolved before the election and some have suggested that these tax cuts may not be addressed until after the new Congress takes office in January. These delays serve to increase the influence that the Presidential candidates' positions on the Bush tax cuts have on their ultimate fate.
Governor Romney generally desires to extend all of the Bush tax cuts permanently.
President Obama wishes to extend most of this tax relief as well, but only for taxpayers below certain income levels. For higher-income taxpayers, whom he defines as couples with annual income over $250,000 ($200,000 for single filers), President Obama would allow these tax provisions to sunset as scheduled. Notably:
- The highest income tax brackets would increase from 33% and 35% to 36% and 39.6%;
- The long-term capital gains tax rate would increase to 20% on most assets; and
- All dividends would be taxed at the individual's marginal tax rate (as high as 39.6%).
While not part of the original Bush tax cuts, another temporary tax cut that will expire at the end of 2012 is the 2% payroll tax holiday. As of January 1, 2012, the employee's share of the FICA payroll tax liability will increase from 4.2% to 6.2%. Despite the fact that letting the payroll tax holiday expire will result in a tax increase for all U.S. workers, even lower and middle income taxpayers, neither candidate has addressed whether the payroll tax holiday should be extended in 2013, though Governor Romney has indicated some support for a "lower payroll tax." Without an extension, a worker earning $50,000 will realize a $1,000 tax increase while taxpayers who earn in excess of the FICA wage base limit ($110,100 in 2012) will experience a tax increase of over $2,200.
Estate and Gift Taxes
Few areas of the tax law have been fraught with more uncertainty and complexity over the last few years than the estate and gift tax area. Estate and gift tax provisions gradually became more generous from 2001 to 2009, followed by a complete repeal of the estate tax for 2010, then retroactive reinstatement of the estate tax with even more generous provisions, only to now face a sunset that will revert the estate and gift tax provisions to their 2001 levels.
President Obama has proposed returning the estate and gift tax provisions to their 2009 levels. Specifically:
- The estate exemption will decrease from $5.12 million to $3.5 million;
- The gift exemption will once again decouple from the estate exemption and revert to $1 million; and
- The highest estate and gift tax rate will increase from 35% to 45%.
While less generous than the 2012 provisions, this proposal is still more taxpayer friendly than the 2001 levels to which the estate and gift tax provisions are scheduled to sunset – i.e., a unified gift and estate exemption of only $1 million and a maximum tax rate of 55%.
Governor Romney has proposed repealing the entire gift and estate tax regime.
Alternative Minimum Tax (AMT)
Before Congress passed the "AMT patch" that increased the AMT exemption and allowed nonrefundable personal credits against the AMT, more and more taxpayers were being ensnared by the AMT each year. The most recent AMT patch expired at the end of 2011. Without Congressional action, an estimated 20 million additional taxpayers will be subject to the AMT in 2012.
President Obama has proposed extending the AMT patch through 2013, but eventually replacing the AMT system with the "Buffett Rule". Under the Buffett Rule, the tax system would be structured in such a way to ensure that taxpayers with over $1 million of income pay an effective Federal income tax rate of at least 30 percent.
Governor Romney has proposed repealing the AMT completely.
Expiring (or Expired) Business Provisions
Whether part of the Bush tax cuts or subsequent economic stimulus acts, several business tax provisions expired in 2011 or are due to expire at the end of 2012, including (not an exhaustive list):
- The research and experimentation tax credit (expired in 2011);
- Bonus depreciation (100% bonus expired in 2011; 50% bonus expires in 2012);
- Enhanced Section 179 expensing election (dropped from $500,000 in 2011 to $139,000 in 2012 and scheduled to revert to $25,000 in 2013); and
- 15-year recovery period for qualified leasehold, restaurant and retail improvement property (expired in 2011).
Both of the candidates have been relatively quiet on these and other expiring business tax provisions, focusing more on long-term corporate tax reform (discussed below). Both candidates agree, however, that the research and experimentation credit should be permanently extended. Both candidates have also expressed some support for extending bonus depreciation, though at what percentage and for how long are unclear.
Long-term Tax Reform for Individuals
While the most immediate need is to deal with the fate of the Bush tax cuts, both candidates have plans for broader individual tax reform. Both candidates wish to simplify the tax system and lower tax rates while keeping the reform revenue neutral, though predictably, they approach the reform in different ways.
Governor Romney has proposed an across-the-board 20 percent reduction in individual tax rates (e.g., the top 35% rate would be reduced to 28%). Ultimately, Romney has stated, his plan would not reduce the share of the overall tax burden paid by higher income taxpayers. Romney has not provided specifics on how the rate reductions would be kept revenue neutral but has indicated that he would broaden the tax base and cap deductions as well as eliminate certain loopholes and tax expenditures. Originally, Romney stated that deductions would be capped at $17,000 but has since backed off of a specific figure.
Romney also wishes to make it easier for middle class taxpayers to save for retirement by completing eliminating taxation on interest, dividends and capital gains for taxpayers with an adjusted gross income of under $200,000.
President Obama does not have a specific platform concerning individual tax reform beyond his plan for the Bush tax cuts and the Buffett Rule (discussed above). In addition to those tax increases on higher-income taxpayers, Obama has also proposed limiting the tax benefit from certain itemized deductions to 28%.
Long-term Tax Reform for Businesses
Our two major political parties do not agree on much these days, but there is a general consensus that corporate tax reform is necessary to keep American businesses competitive in the global economy.
Corporate tax rates
President Obama's corporate tax reform plan starts with a reduction in the top corporate tax rate from 35% to 28%. He also would increase the Domestic Production Activities Deduction to further decrease the tax rate on manufacturing income to 25% and an even lower rate for "advanced manufacturing."
To offset the tax rate reductions, President Obama would eliminate several business tax "loopholes" and tax expenditures, including:
- LIFO inventory accounting,
- Oil and gas tax preferences,
- Interest deductions on corporate life insurance policies,
- Special depreciation on corporate aircraft, and
- The taxing of carried interests at capital gains rates.
President Obama would also consider reforming several other areas of the tax code that cause purported distortions in the tax base, including:
- Accelerated depreciation,
- Reducing the bias towards debt financing by limiting interest expense deductions, and
- Establishing greater parity between corporate and pass-through entities by taxing large pass-through entities as corporations.
Governor Romney also wishes to lower the corporate tax rate, but to 25% for all corporations, and would also repeal the corporate AMT. Romney has indicated that he would explore further rate reductions in conjunction with broadening the income base and simplifying the tax code. Governor Romney has not indicated what, if any, tax expenditures he would eliminate to offset the cost of the reduction in corporate tax rates.
International tax reform
While there may be some agreement between the two candidates on the need to lower corporate tax rates, they have very different views as it pertains to international tax reform.
Governor Romney's primary concern is to ensure that U.S. companies are competitive with their foreign counterparts. He believes that our worldwide tax system, which taxes foreign income at U.S. rates regardless of where it is earned, causes U.S. businesses to pay higher taxes than foreign companies doing business in low tax jurisdictions, especially given our comparatively high corporate tax rates. Romney also believes that U.S. businesses are discouraged from repatriating foreign profits to the U.S. and investing those profits domestically since foreign earnings are not taxed in the U.S. until they are brought home.
Therefore, Governor Romney proposes moving towards a territorial tax system in which income is only taxed in the country in which it is earned. He believes that this change, when combined with a lowering of corporate tax rates, will greatly significantly increase corporate investment in the U.S. Romney also acknowledges that the new regime will need to be structured in such a way that does not encourage corporations to "game the system" and export jobs or move their headquarters abroad.
President Obama's concern over shifting jobs and profits out of the United States is why he suggests a different approach. President Obama believes that we should maintain our worldwide tax system and, in addition, impose a minimum tax on foreign profits to discourage U.S. companies from parking profits offshore in low-tax jurisdictions.
President Obama has made some other proposals intended to protect U.S. jobs, including:
- Eliminating tax deductions for moving business operations abroad,
- Creating a 20% tax credit for expenses of moving operations back into the U.S.,
- Currently taxing excess profits associated with shifting intangibles to low tax jurisdictions, and
- Delaying the deduction for interest paid on overseas investments until the related income is taxed in the U.S.
Only Part of the Story
While the Presidential candidates' positions on expiring tax provisions and long-term tax reform garner most of the attention, ultimately Congress is responsible for passing any legislative changes. Already in recess for the fall campaign season, Congress will not address any of the expiring tax provisions until after the November election. While many are predicting that some of the expiring provisions, including the Bush tax cuts, will be extended for another year, which provisions will be extended and for which taxpayers remain to be seen. Who wins the White House and who controls each chamber in Congress (and by how much) may dictate what gets extended and whether those provisions are extended for all taxpayers or only those below certain income levels.
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