Making Work Pay credit

The centerpiece of President Obama’s individual tax incentives is the Making Work Pay credit. Many individuals are already receiving the benefit of this credit in their paychecks. The credit reaches $400 for single taxpayers and $800 for married couples filing joint returns if they fall below certain income limits. The credit, however, is temporary and will expire after 2010. President Obama is asking Congress to make the credit permanent but many in Congress worry that a permanent credit would be too expensive.

More middle-income Incentives

Several other incentives are also targeted to middle-income taxpayers. These include marriage penalty relief, a permanent American opportunity education tax credit and permanent extension of lower individual marginal income tax rates (except for the 36 and 39.6 percent rates). The president has also proposed extending the state and local sales tax deduction, the higher education tuition deduction, the teacher’s classroom expense deduction, the saver’s credit, and the deduction for charitable contributions of IRA funds. These proposals enjoy significant support in Congress and are expected to pass.

President Obama did not propose extending several new tax breaks. These include the first-time homebuyer credit, which sunsets after December 1, 2009, and the deduction for state and local taxes paid on motor vehicles, which expires after December 31, 2009. The first-time homebuyer is popular in Congress and lawmakers may extend it one or two more years, especially if home sales remain slow.

Higher-income taxpayers

More controversial are the president’s proposals for higher income individuals. As mentioned, the top two individual marginal income tax rates would revert to 36 and 39.6 percent after 2010. President Obama has also proposed reinstating and expanding limitations on itemized deductions for higher-income individuals along with reinstating the personal exemption phaseout for higher-income individuals.

The White House generally defines higher-income taxpayers as individuals with incomes above $200,000 and families with incomes above $250,000. It is unclear if these amounts refer to taxable income or adjusted gross income. More details are expected to be released when legislation is introduced in Congress.

Children

One of the most popular federal tax incentives is the child tax credit. The 2009 Recovery Act expanded the credit. President Obama has proposed making the enhanced child tax credit permanent.

The president has also recommended a permanent enhanced earned income tax credit (EITC). Under current law, more families are eligible for the EITC. However, the president has proposed eliminating the advanced EITC, which provides the credit in advance through payroll.

Capital gains

Under current law, the maximum tax rate on qualified capital gains and dividends is 15 percent. Some taxpayers may be eligible for a zero percent rate. These rates are temporary and will expire after 2010. President Obama has asked Congress to extend the lower rates for middle-income taxpayers. However, higher income individuals would be taxed at 20 percent on qualified dividends and capital gains under the president’s plan.

Health care

Congress has just started debating comprehensive health care reform. Lawmakers are looking for ways to fund health care reform. Under current law, the amount that an employer contributes to an employee’s health coverage is generally excluded from the employee’s taxable income. One idea being floated in Congress is to cap the tax exclusion for employment-based health care coverage. Administration officials have generally indicated their support for continuing the exclusion.

Retirement savings

During the campaign, then-candidate Obama often spoke about strengthening retirement savings, especially 401(k)s and similar defined contribution arrangements. The president has made one official proposal: mandatory automatic enrollment in IRAs. Generally, employers without a retirement plan would be required to offer automatic enrollment in an IRA to all employees on a payroll-deduction basis. White House officials have also discussed some “unofficial” proposals, such as the partial annuitization of 401(k)s, to strengthen retirement savings.

Estate tax

Eight years ago, Congress voted to repeal the federal estate tax for 2010. At that time, many observers predicted that repeal would be permanent. The recession has brought about different thinking. Instead of repealing the estate tax, the president has proposed extending the current rate of estate tax and exemption amount into 2010.

Congress has a lot of tax legislation on its agenda and is expected to enact much of it into law in late summer or early fall, maybe sooner. Our office will keep you posted of developments and please contact us if you have any questions.

Tax hikes

The Obama Administration’s budget would establish a $600 billion reserve fund for overhauling the health care system, to be partially funded by tax increases on higher income taxpayers. These are taxpayers with adjusted gross incomes (AGI) over $200,000 for individuals and $250,000 for married couples filing jointly. Specifically, the budget proposes to raise the highest tax rates to 36 and 39.6 percent after the 2001 Bush tax cuts expire at the end of 2010.

The proposed tax increase on individuals has been met by lawmakers on Capital Hill and small businesses with significant criticism since many small businesses such as limited liability companies, S corps, and partnerships pay income tax at the individual level. According to some lawmakers, under Obama’s proposed budget, small businesses would face a 45 percent tax hike. But Treasury Secretary Timothy Geithner has asserted that 97 percent of small businesses would not see a tax increase.

The budget would also limit itemized deductions to 28 percent for high-income taxpayers, including the mortgage interest, real estate tax and charitable deductions. The budget also proposes a 20 percent rate on capital gains and dividends, again, on high-bracket taxpayers after 2010. Obama has also proposed to reinstate the personal exemption phase-out.

Permanent tax cuts

Obama has also proposed making the following tax incentives, which are currently temporary, permanent:

– Making Work Pay credit of $400 for individual wage earners and $800 of married taxpayers;

– An enhanced child credit;

– American Opportunity Tax Credit (formerly the Hope education tax credit); and

– An expanded earned income tax credit (EITC).

Mandatory retirement savings enrollment

The budget’s proposed mandate for all small businesses to automatically enroll their employees in either a 401(k) or IRA established by the employer also create concern among lawmakers during a time when businesses cannot afford to make matching contributions.

Obama has stressed that his budget proposals are continuing to be fleshed out, and that the Administration is willing to be flexible in making changes.