President Obama released his fiscal year 2015 budget last week by submitting to Congress a 3.9 trillion federal budget proposal aiming to increase government revenue by way of several large tax changes and numerous small ones. While there are some favorable provisions, we expect this proposal will increase tax burdens for most of our clients. Below are the proposals that we feel may impact you the most.
Impact to Individuals
Self-Employment Tax on Certain S Corporation Shareholders
The president’s proposal aims to impose self-employment taxes on individual S-corporation shareholders who materially participate in professional service businesses. Currently, S Corporations shareholders pay income tax on income that passes to them through their S Corporations, but are not required to pay self-employment tax on the same income. Instead, most receive a reasonable salary and incur payroll tax on wages they earn. Under Obama’s proposal, owners providing services in certain fields, including health, law, engineering, performing arts, accounting, architectural, actuarial sciences, brokerage, and consulting, would be subject to self-employment tax on their distributive shares of income.
Limited itemized deductions claimed by high-income taxpayers.
This change would limit the value of certain itemized tax deductions and exclusions for individuals with taxable incomes in or over the 33 percent bracket. The proposal would limit the deductible value of these deductions and exclusions to 28 percent. For example, if an individual is currently in a 39.6 percent tax bracket, a $10,000 401k contribution would save them $3,960 on their federal income tax return. Under Obama’s proposed budget, the same contribution would only save them $2,800, resulting in an additional tax of $1,160. This is the largest revenue raiser in the 2015 FY budget.
The proposed change affects many new areas previously not taxed, such as the benefit from tax exempt interest, health insurance costs including some group insurance coverage, retirement contributions, and the itemized deductions other than charitable contributions.
The Buffet Rule or “Fair Share Tax
This proposal would levy a minimum tax of 30 percent on high income taxpayers. The provision would be phased in for taxpayers with modified adjusted gross income starting at one million and would be fully phased in at two million.
Estate and Gift Tax Increase
Currently the maximum unified estate and gift tax rate is 40 percent with an inflation adjusted exclusion of $5 million for estates of decedents dying after December 31, 2012. The budget proposes to increase the Estate tax rate from 40 percent to 45 percent and lower the exclusion amounts to $3.5 million for estate taxes, $1 million for gift taxes and $3.5 million for generation skipping taxes. Furthermore, these amounts would not be indexed for inflation.
Limitation on retirement accounts
The president would curtail the maximum balance allowed in tax-favored retirement accounts so as to prevent wealthy individuals from establishing tax-deferred assets above certain levels.
The minimum distribution requirements would be eliminated for individuals whose IRA and retirement plan accumulations do not exceed $100,000 in aggregate. The proposal would include individuals attaining age 70 ½ .
Expansion of the Earned Income Tax Credit and Child Tax Credit
The Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC) are refundable tax credits aimed at working families. The size of these credits depends on income, marital status, and number of children.
Obama’s proposal would increase the EITC for taxpayers without qualifying children. The proposal would also reduce the minimum age a taxpayer is eligible to receive this credit from 25 years to 21 years of age. The Child Tax Credit would also be expanded.
Current law limits the amount of charitable deduction available for conservation easements to 30 percent of adjusted gross income. A provision in effect from 2006 to 2013 had increased that limit to 50 percent of adjusted gross income for most individuals and up to 100 percent for farmers and ranchers. The administration’s proposal would be to make permanent the enhanced limitations that expired in 2013.
Impact to Businesses
Repeal of LIFO
The Obama budget proposes to repeal the last-in, first-out (LIFO) method of accounting for inventories. This will impact our manufacturing clients and others who currently are on the LIFO method. Repealing LIFO would force taxpayers to recapture LIFO reserves as ordinary income over a 10 year period.
Auto Enroll IRAs and a Cap on Retirement Accounts
This proposal would require small businesses with more than ten employees to automatically enroll workers into an individual retirement account (IRA). Employees would be able to opt-out if they choose. Businesses would receive tax credits to offset the cost of setting up these programs.
Top Corporate Tax Rate
The Administration calls for a top corporate tax rate of 28 percent with a 25 percent rate for manufacturers. Currently the top federal tax rate for corporations is 35 percent.
Extension of Section 179 Benefits
The president’s budget would make permanent the Section 179 expense election for small businesses. This expense election allowed taxpayers to deduct $500,000 per year of qualifying property with an investment limit of $2,000,000 in 2013. However, the expense limit dropped to $25,000 in 2014 with an investment limit of $200,000. The proposal would set the limits back to what they were in 2013.
Start up / Organizational Expenditures
Currently, start up and organizational costs are allowed to be deducted up to $5,000 for each category with the remainder amortized over 180 months. The President proposes to combine these two categories and offer a maximum $20,000 up front deduction limit, reduced to the extent the total of these two expenditures exceed $120,000, then allowing the excess to be amortized over 180 months.
Research and Development Credit
The budget would enhance and make permanent the Research and Development credit which expired at the end of 2013. The proposal would also increase the rate of the alternative simplified credit.
Like Kind Exchange Limitations
A new proposal would limit the amount of capital gain deferred under a like kind exchange transaction (Code Section 1031) to $1 million per year per taxpayer for exchanges occurring after December 31, 2014.
Insourcing and Outsourcing
Obama proposed a general business credit of 20 percent of eligible expenses for “insourcing” a U.S. trade or business, available to a company that reduces or eliminates a trade or business (or line of business) conducted outside the U.S. and starts up or expands the same trade or business within the U.S. In addition, the proposal would disallow deductions for expenses paid for outsourcing a U.S. trade or business.
Promise Zone / Manufacturing Communities
The administration seeks to create economic zones and communities within which special tax breaks would be available to promote job creation and investment in economically challenged areas of the country who have suffered major job loss.
The FY 2015 budget would extend and enhance existing incentives to encourage the production and use of “clean energy” through new and amended proposals. Incentives would include tax credits and deductions for alternative fuels, energy efficient construction, and advanced energy projects.
The administration proposes the requirement that calendar year partnership and calendar year S Corporation returns be due by March 15. Currently partnership returns are due April 15th.
We will continue to monitor any tax developments and keep you informed as we move further into 2014.