With just a few days before the President delivers his 2015 State of the Union address to Congress, the White House has released a “sneak peek” of what we can expect. Not surprisingly, tax and economic reforms will be on the President’s agenda for 2015 as he seeks to close what he terms “unfair loopholes that are only available to the wealthy and big corporations” (perhaps another inappropriate use of the term “loophole”).
What should you expect to hear during the State of the Union? Key proposals from the President include:
- Eliminating stepped up basis. Calling it “the single largest capital gains tax loophole” (again, I’m not sure that the President understands that word), the President proposes to eliminate stepped up basis at death. With stepped up basis, heirs may use the date of death value of capital assets rather than a decedent’s actual basis for capital gains purposes. This allows those assets – stocks, bonds, houses and companies – which have appreciated to be transferred at death without paying capital gains tax. The tax policy behind stepped-up basis is tied to the federal estate tax: since heirs pay the estate tax, they get a pass on capital gains. That’s why, for example, in 2010, when there was no federal estate tax, there was no stepped up basis. Under the President’s proposal, no capital gains tax would be due until the death of the second spouse for married couples and capital gains of up to $200,000 per couple ($100,000 per individual) would be exempt; the exemption would be automatically portable between spouses as it is for the federal estate tax. An additional$500,000 exemption ($250,000 per individual) would apply to personal residences – this is the same exemption amount that applies to the sale of personal residences during lifetime. Tangible personal property (generally, things you can touch like furniture and clothing) other than expensive art and similar collectibles would also be exempt.
And, because you know the argument is coming, the proposal would also exempt inherited small, family-owned businesses from capital gains tax at death unless and until the business was sold. Any closely-held business subject to capital gains tax would have the option pay out over 15 years.
The President claims that this move, together with raising the rates on high-income taxpayers (see below), would impact only those at the top and would “address a basic unfairness in the tax system.”
- Raising capital gains and dividend rates. Capital gains and dividends rates have been reduced over the past thirty years or so, purportedly to encourage investment. Those rates were 28% for high-income taxpayers during the Reagan Era but have since dropped to the current levels (generally, 20% at the top, 15% for those in the middle). The President’s plan would push those rates back up for those at the top.
- Establishing a new tax credit for double-income families. Calling it a “new, simple tax credit” (note to the President: rarely is that ever true), the President proposes providing a tax credit of up to $500 for families with two working spouses. The credit would be equal to 5% of the first $10,000 of earnings for the lower-earning spouse in a married couple, and the maximum credit would be available to families with incomes up to $120,000, with a partial credit available up to $210,000.
- Increasing child care tax incentives. The President proposes boosting the child care tax credit (sometimes called dependent care tax credit) up to $3,000 – triple what it is now – but only for middle class families with children under five years old.
- Revamping education tax benefits. The President’s plan would consolidate existing education tax benefits into two – a move that he says will “simplify, consolidate, and expand education tax benefits to improve college affordability.” The move would, according to the White House, allow more students up to $2,500 in tax breaks each year over five years. Specifically, the Lifetime Learning Credit and the tuition and fees deduction would be eliminated and replaced by an expanded American Opportunity Credit (AOC). The refundable piece of the AOC would also be increased.
In what’s sure to be a controversial move, the proposal would also eliminate tax on student loan debt forgiveness under Pay-As-You-Earn (PAYE) and other income-based repayment plans; Congress hasn’t been inclined to do that previously. The President also proposes repeal of the student loan interest deduction for new borrowers.
- Expanding the Earned Income Tax Credit (EITC). Despite heavy criticisms of the EITC (which has become a magnet for tax fraud), the President suggests expanding the credit. The President’s proposal would double the EITC for workers without qualifying children, increase the income level at which the credit phases out, and make the credit available to workers age 21 and older. Some variation on this provision has been tossed about by both parties before. The EITC currently provides benefits to low-income working families.
- Boosting IRA options. Remember that “myRA” the President proposed last year? Nobody else does either. But the President is nonetheless trying again with new retirement savings proposals. At the top of the list? Every employer with more than 10 employees that does not currently offer a retirement plan would be required to automatically enroll their workers in an IRA – called an “auto-IRA.” To ease the pain of having to offer the plan, the proposal would provide any employer with 100 or fewer employees who offers an auto-IRA a $3,000 tax credit. The existing “start up” credit for small businesses who offer the new retirement plan would be tripled to offset administrative expenses; existing employers who already offer a plan and add auto-enrollment would get an additional $1,500 tax credit. The proposal would also demand that employers who offer retirement plans permit part-time employees who have worked at least 500 hours per year for 3 years or more to make voluntary contributions to the plan.
The President’s plan would also bar contributions to and accruals of additional benefits in tax-preferred retirement plans and IRAs once balances have reached $3.4 million.
These proposals are certain to meet with disapproval among some Republicans – and likely some Democrats – on the Hill. Will the President eke out some sort of compromise? It could happen. Traditionally, most nods towards tax reform have happened with a two-term President in office. President Obama, currently serving his second term, is set to leave office in 2017.