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Analysis: Obama Budget Proposal Adds New Tax Increases for Wealthy Individuals, Businesses and Estates

June 10, 2009 (SmartPros) President Obama unveiled new tax increases for wealthy individuals and estates with the recent release of his final budget proposal.

The new budget builds on the blueprint Obama offered in February, but includes new tax provisions to raise revenue. The revenue raisers would greatly impact high-income taxpayers and pass-through businesses that are taxed on the individual level. Three of the newly proposed increases would make significant changes to estate tax law and planning.
"Wealthy individuals and business owners would be among the hardest hit if the president's proposed tax provisions are enacted," said Justin Ransome, a Private Wealth Services partner in Grant Thornton's National Tax Office.
The estate tax is scheduled to completely expire in 2010 before coming back in 2011 with an exemption of just $1 million and a top rate of 55 percent. Obama proposes to extend permanently the 2009 estate tax law with an exemption of $3.5 million and a top rate of 45 percent, but also proposes the elimination of certain common and accepted estate planning techniques.
  • Valuation discounts - Taxpayers can generally discount the value of assets for estate and gift planning purposes by creating a family limited partnership (or limited liability company) that limits the control and marketability of the assets. The administration proposes restricting taxpayers from applying these discounts when transferring assets to heirs.
  • Minimum GRAT term - The administration proposes a new minimum term requirement of 10 years for grantor retained annuity trusts (GRATs). This would make a GRAT a riskier planning technique because the transfer tax benefits of GRATs are typically achieved when the grantor outlives the GRAT term.
  • Consistency in valuations - This proposal would require taxpayers who inherit property to use the value of the property that was assigned for estate tax purposes as their basis. Basis is used to determine a capital gain or loss when property is sold.
"The enactment of these proposals could change the estate tax planning strategies for many individuals," said Ransome.
Obama's final budget proposal also includes provisions to raise marginal tax rates on high-income taxpayers, increase how much they pay on capital gains and dividends, and reduce or eliminate their personal exemptions and deductions. All of these increases would generally take effect at income levels of $200,000 for singles and $250,000 for married couples, though the definition of income varies among the proposals. The proposed changes that would impact taxpayers over these high-income thresholds include:
  • Rate increase - The budget proposes to return the top two marginal rates to their levels before the Bush 2001 tax cuts. The top two brackets would increase from their current 33 percent and 35 percent rates to 36 percent and 39.6 percent in 2011.
  • Capital gains and dividends - Long-term capital gains and qualifying dividends would be taxed at 20 percent for taxpayers above the new high-income threshold, while the rate would remain at 15 percent for everyone else. This would be a slight improvement over the rules before the 2003 Bush tax cuts, when long-term capital gains were taxed at 20 percent, but dividends were taxed as ordinary income up to a top rate of 39.6 percent.
  • PEP - The final budget would reinstate the personal exemption phaseout (PEP) in 2011 so that the value of personal exemptions taxpayers receive for themselves, their spouses and children ($3,650 each in 2009) would be reduced by three percent for all incomes above the new high-income threshold. The Bush tax cuts in 2001 gradually repealed PEP so that it would be completely gone in 2010.
  • Pease - Bush's 2001 taxes cut also gradually repealed the so-called "Pease" phaseout of itemized deductions at high income levels. Obama's final budget proposes to reinstate Pease in 2011, which would limit most deductions by up to 80 percent for income over his high-income threshold. Deductions for a few items, such as medical expenses and theft losses, do not phase out under Pease.
  • Deduction rate limit - The final budget also proposes a brand new additional limit on all itemized deductions. The value of a deduction depends on a person's tax rate. Someone paying taxes in the 28 percent bracket (pre-2001) would generally save $28 in taxes for every $100 in deductions, while a taxpayer in the 39.6 percent bracket would save $39.60. The new budget proposal would limit the value of all deductions to a maximum of 28 percent so taxpayers in the 36 percent and 39.6 percent brackets would save less on deductions for things like mortgage interest and charitable gifts.

2009 SmartPros Ltd. All rights reserved.

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