Tax Edge

The Obama Administration released its complete FY 2010 federal budget proposal on May 11, including President Obama's ambitious effort to revise portions of the tax code. This proposal provides the detail following the February release of the basic outline of his budget. The tax proposals include raising the top marginal tax rates for individual income tax, extending permanently the new "making work pay" credit, and extending other tax incentives currently available, largely targeted to middle-income families. The administration's budget also urges Congress to increase tax revenues by revising the way foreign earned income is taxed and repealing the last-in, first-out (LIFO) method of accounting for inventories, among other things.

The current marginal income tax rate structure has been in place since 2001. However, it will expire after 2010, and the marginal rates for all taxpayers will rise, unless Congress takes action. President Obama's budget proposal allows the current, lower tax rates to be continued for most taxpayers, but calls for the top two marginal tax rates to be raised from 33 and 35 percent to 36 and 39.6 percent, respectively, for single individuals with incomes above $200,000 and married couples filing jointly with incomes above $250,000. The proposal also expands the 28-percent bracket to higher income levels so that taxpayers below these income thresholds are not affected by the tax rate increases. Also proposed is a limitation on the itemized deductions allowable for taxpayers with incomes above these thresholds. Their itemized deductions would only be allowed to reduce tax liability at a rate of 28 percent, even though their marginal tax rate would either be 36 or 39.6 percent on their regular taxable income.

The administration proposal would also increase from 15 percent to 20-percent the tax rate on capital gains and dividends for individuals with incomes above $200,000 and married couples filing jointly with incomes above $250,000. The higher rates would take effect after 2010. The current, lower rates would continue to apply to individuals and married couples whose incomes are below these thresholds.

The centerpiece of the President's economic stimulus package, the American Recovery and Reinvestment Act of 2009 (the ARRA), is the making work pay credit. The administration renewed its call for Congress to make permanent the temporary credit, which generates annual tax savings of up to $400 for qualified individuals and $800 for married couples filing jointly. Without action by Congress, the tax credit will expire after 2010. The cost of a permanent making work pay credit would be offset, the administration projected, with revenues from climate-change legislation.

As additional tax incentives targeted to individuals, the administration proposes to make permanent the current child tax credit, earned income tax credit (EITC), and American Opportunity education tax credit, each of which would otherwise shrink or expire after 2010. Also, the current saver's credit would be expanded, and automatic employee enrollment in IRAs would be mandated.

Two other very important assumptions are built into the President's budget. First, it assumes that Congress will permanently "patch" the alternative minimum tax (AMT) with an inflation adjustment factor, as it has done year by year for the past several years. This would keep millions of taxpayers from being subject to AMT. Second, it assumes the estate tax law is permanently fixed by extending the current 2009 provisions into the future with only an inflation adjustment factor. This would settle the otherwise dramatic upheaval that will occur in estate tax law after 2009 unless action is taken, and sets the exemption amount at $3.5 million and the maximum tax rate at 45 percent.

The administration appears to be taking a cautious approach to so-called tax extenders. These are popular but temporary tax breaks, such as the state and local sales tax deduction, the teacher's classroom expense deduction and others. "Our general approach on the extenders is to extend them for a two-year period," Treasury officials said. Some of the new temporary tax breaks, such as the first-time homebuyer credit and the deduction for state sales tax on the purchase of a motor vehicle, are not included for extension in the administration's FY 2010 budget request. The administration also does not recommend extending the temporary premium assistance for COBRA continuation coverage.

Deficit Projections

The federal deficits in FY 2009 and FY 2010 are expected to be $90 billion higher each year than the administration's February forecast, according to the May 11 budget documents released by the Office of Management and Budget (OMB). OMB Director Peter Orszag noted that, overall, federal revenue estimates decreased between $30 billion and $50 billion in 2009 and 2010 compared to the February projections. As a result, the expected FY 2009 deficit is $1.84 trillion and the expected FY 2010 deficit is $1.26 trillion. The expected 2009 deficit is four times higher than the highest deficit the U.S. has ever had - the 2008 deficit of $459 billion.

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Posted May 18, 2009.