Individual Income Tax Provisions of Pres. Obama’s Fiscal Year 2014 Budget Proposal

On April 10, 2013, Pres. Obama released his budget proposal for the Federal government’s fiscal year running from October 1, 2013 through September 30, 2014.  The budget proposal includes many individual and business income tax provisions, projected to increase taxes by $1.1 trillion over 10 years according to the Tax Policy Center.  While many of the provisions have previously been proposed, there are also new provisions.  It is unlikely that all of these provisions will be enacted, but the following list indicates possible future changes that are worth noting as you contemplate your personal and business financial and tax planning strategies. 

1.     Reduce the tax savings from deductions and exclusions to an effective 28% tax rate for taxpayers in the top three income tax brackets (33%, 35%, & 39.6%), effective for tax years beginning after 2013.  Using 2013 rate brackets as an example, this tax increase would hit single filers and joint filers having taxable income in excess of $183,250 and $223,050 respectively.  The proposal would affect the following deductions and exclusions:

a.      Itemized deductions after all other limitations,

b.     Tax-exempt interest,

c.      Employer-paid health insurance premiums excluded from compensation,

d.     Employee-paid health insurance premiums made with pre-tax dollars,

e.      Self-employed health insurance premium deductions,

f.      Deductible IRA and retirement plan contributions,

g.     Domestic production activity deductions,

h.     Moving expenses,

i.       Contributions to health savings accounts and Archer MSAs,

j.       Interest expense on education loans,

k.     Deduction for college education expenses, and the

2.     Implement the so-called “Buffett” rule requiring taxpayers with over $1 million of adjusted gross income to pay a “fair share tax.”  The fair share tax phases in on a prorata basis so that by $2 million of AGI, the effective over-all tax rate would be no less than 30%.  Any itemized charitable deductions allowed after the overall limitation on itemized deductions would be allowed as a credit of 28% against the fair share tax.  The 30% effective rate is imposed after considering the regular tax, the alternative minimum tax, the 3.8% Obamacare surtax on net investment income, and the employee portion of payroll taxes.  The fair share tax would essentially be another alternative minimum tax, greatly complicating the tax code.  It would also dramatically increase the effective tax rate on long-term capital gains and qualified dividend income.  The fair share tax is proposed to be effective after 2013.

3.     Extend permanently the American Opportunity Tax Credit for college expenses.  The current credit structure is scheduled to expire after 2017.

4.     Impose a new lifetime overall limit on savings accumulated in tax-favored retirement accounts such as IRAs, profit sharing plans, 403(b)’s, and 401(k)s.  If the sum of all of the plan balances (including contributions and reinvested earnings) exceeds the amount needed to provide a lifetime annuity equal to the maximum amount permitted under a defined benefit plan (a joint and survivor annuity of $205,000 (for 2013) per year starting at age 62), then no more contributions or benefit accruals can be made, although the account balances may continue to grow with investment earnings and gains.  Currently, this amount is estimated to be $3.4 million.  This amount is susceptible to interest rates swings.  For example, the Wall Street Journal mentions in their article, (Will the Government Shrink Your IRA?) that in 2006 the amount needed to pay the permitted annual benefit would have only required $2.2 million.  If the accumulated retirement savings later fall below the designated level, additional contributions and accruals will be permitted.  The measurement would be made each December 31^st with any limitation on contributions or accruals applying to the following calendar year.  This proposal would be effective for tax years beginning after 2013.

5.     Require non-spouse beneficiaries of IRAs and qualified plans to receive their inherited benefits within five years.  This proposal would eliminate life-time stretch-out distributions of inherited benefits for non-spouse beneficiaries.  This proposal appears to include Roth IRAs, making taxable conversions from traditional IRAs to Roth IRAs for estate planning purposes much less attractive.  Exceptions from the five-year rule would be provided for beneficiaries who are disabled, chronically ill, minor children (but the five-year rule will apply at the age of majority), or those who are not more than 10 years younger than the participant or IRA owner.  This proposal is effective for deaths after 2013.

6.     Permit all inherited IRA balances to be rolled over within 60 days.  Currently, the rollover provision is only permitted to surviving spouses.  Non-spouse beneficiaries currently can only make direct trustee-to-trustee transfers.  This is a trap for the unwary.  A direct transfer is not possible for a distribution from an IRA, whereas a rollover applies to distributions.  This proposal would be effective for distributions after 2013.

7.     Eliminate the requirement to take minimum distributions from IRAs where total IRA and qualified retirement plan balances are $75,000 or less.  Although Roth IRAs are exempt from pre-death RMD rules, amounts held in Roth IRAs would be taken into account in determining whether the $75,000 threshold is met.  The RMD would phase-in between $75,000 and $85,000.  The initial measuring date is January 1^st of the year in which the taxpayer reaches age 70 ½ (or the year of death if earlier).  Subsequent measurement dates would occur on January 1^st of the year following any year in which there are additional contributions, rollovers, or transfers that weren’t previously included in a measurement.  This proposal is effective for taxpayers who attain age 70 ½ on or after December 31, 2013 and for taxpayers who die on or after that date before attaining age 70 ½.

8.     Require the use of the so-called chained Consumer Price Index (CPI) instead of the standard CPI to measure the rate of inflation when indexing tax brackets, exemptions, and other tax benefits after 2014.  The chained CPI produces a lower rate of inflation, thereby increasing taxes because the size of the deductions, exemptions, and tax brackets will correspondingly be lower.  One of the main differences between the two CPI indexes is that the chained CPI assumes that a person will substitute cheaper and perhaps lower quality goods in place of those whose prices have increased.