2009 Stimulus and Tax Plans

The 44th President of the United States, President Obama, along with the 111th Congress, will face enormous challenges in the current economic environment as they design and implement effective U.S. tax, monetary, and economic policies. With an inaugural theme that commemorates the 200th anniversary of Abraham Lincoln’s birth, we recall the core principle cited by Lincoln in his first inaugural address, that our country’s wealth is produced by the work undertaken by the American people. Based on that premise, the incoming Administration’s objective is to create a stimulus and tax plan that will help restore America’s economic prosperity.

With this special report, Frank, Rimerman + Co. LLP has summarized the primary components of President Obama’s 2009 economic stimulus plan and the related individual and corporate tax provisions. In addition, we have summarized the primary components of the House of Representatives’ stimulus plan unveiled January 15, 2009. While the drafting of a Senate version of a stimulus plan is underway, full details are not yet available.

We will be releasing future summaries of the pending stimulus and tax legislation as it continues to evolve, and as additional details become known.

1. Summary of House of Representatives Stimulus Plan

On January 15, the House Democrats unveiled an $825 billion stimulus package with a heavier tilt toward spending and away from tax incentives, in contrast to what had been widely expected. The centerpiece of the plan is tax cuts to provide direct tax relief to 95% of American workers, and to encourage investment and job growth for American businesses.

At this point it appears there will be no immediate tax increase on those taxpayers earning more than $250,000 to fund the proposed tax reductions to working families who are the focus of the President’s and the House Democrats’ plans. During the President’s campaign he stated a view to restore the top two individual income rates (36% and 39.6%) in effect during the Clinton administration; today the top rate is 35%. However, in the current economic environment an increase in the present 35% tax rate may not help create the overall desired stimulus effects. Similarly, none of the proposals we are discussing herein contain provisions related to carried interests.

The package devotes $275 billion, or one-third of its total cost, to tax relief, according to releases from the House Appropriations and Ways & Means committees. That figure is substantially less than the $300 billion that presidential transition aides said was their target when negotiations began. The overall package is larger than early projections of $775 billion but less than the $850 billion that recent reports indicate are desired by the President. The House plan does not include complete cost estimates, but broadly speaking, direct spending and individual tax breaks appear to have grown from early projections while business tax relief has been reduced. House Speaker Nancy Pelosi (D-CA) expects the bill to change in markup hearings before the House Appropriations, Energy and Commerce, and Ways and Means committees this week.

Considering the House of Representatives’ stimulus plan provisions, the pending Senate plan provisions, and the President’s desired provisions, we expect extensive reconciliation of legislative differences as the varied plan provisions evolve.

According to the House Democrats’ summary of January 15, in addition to the “Making Work Pay” credit, tax provisions targeting individuals would:

  • An appraisal consistent in substance and principles with the Uniform Standards of Professional Appraisal Practice (USPAP) dated no earlier than 60 days before the date of the gift and no later than the due date of the tax return reporting the gift
  • repeal a repayment requirement for a temporary $7,500 first-time home buyer’s tax credit for homes purchased from January 1, 2009 through June 30, 2009;
  • expand eligibility for the earned income tax credit and the child tax credit; and
  • create a “simplified,” 40% refundable, $2,500 tax credit for higher education costs.

A one-year patch of the alternative minimum tax (AMT) was not included in the plan. It is believed the Senate will add an AMT patch to its version of the plan.

Business and corporate tax incentives include:

  • a five-year net operating loss carryback period that would be unavailable to companies receiving assistance through Treasury’s Troubled Assets Relief Program (TARP);
  • extensions of higher expensing limits under IRC Sec. 179 and 50% bonus depreciation;
  • expansion of a tax credit to promote hiring of disadvantaged youth; and
  • a repeal, beginning after the date of enactment, of controversial Treasury guidance dealing with the treatment of built-in losses under IRC Sec. 382.

The following summarizes the President’s stimulus plan provisions, with the House of Representatives provisions and Senate provisions, as presently known.

2. Individual Income Tax Rate Modifications

In addition to President Obama’s Plan provisions, currently there are bills in the House of Representatives that would modify individual income tax rates, including the tax rate on qualified dividends and net capital gains.

First, the proposed Economic Growth Through Tax Stimulus Act of 2009 (H.R. 301 released January 10) would repeal the 2001 and 2003 tax rates and temporarily reduce the individual and corporate tax rates for tax years beginning after 2008 and before 2014.

Regarding the current individual ordinary income tax rates, the 10% and 15% rates would each be reduced by 5 percentage points; the 25% rate would decrease to 20%, the 28% rate would decrease to 23%, and the 33% and 35% rates would decrease to 25%. However, the current 15% individual income tax rate on qualified dividends and net long term capital gains would be repealed. The effect of these proposals would be to tax long term capital gains at 20%. Qualified dividends would be taxed at the reduced ordinary income tax rates cited above.

Similarly, yet separately, the proposed Economic Recovery and Middle-Class Tax Relief Act of 2009 would repeal the sunset of the Bush income tax rate reductions and provide for reduced ordinary income tax and capital gains tax rates. Under this proposed legislation, individual income tax rates would be reduced by 5% effective for the 2008 tax year. Therefore, the current 10% rate would be reduced to 9.5%, the 15% rate would be reduced to 14.25%, the 25% rate would be reduced to 23.75%, the 28% rate would be reduced to 26.6%, the 33% rate would be reduced to 31.35%, and the 35% rate would be reduced to 33.25%. As a result, long-term capital gains would be taxable at the rate of 20%. Qualified dividends would be taxed at the somewhat reduced ordinary income tax rates noted above.

The latter bill provides relief from income taxes on net capital gains by indexing certain assets for purposes of determining gain or loss. The tax basis of an indexed asset would be increased by an applicable inflation adjustment. This amendment would be effective on the date of the enactment of the act.

3. Corporate Tax Rate Modifications

The proposed Economic Growth Through Tax Stimulus Act of 2009 would also decrease the corporate income tax rate to 15% on taxable income less than $50,000 and to 25% for the balance of taxable income.

A provision that could be included in President Obama’s plan is a proposal to reduce the corporate income tax rate, as introduced in 2007 by U.S. Rep. Charles Rangel (D-NY). Rep. Rangel’s proposal, which remains viable in the current legislative process, would reduce the top corporate marginal income tax rate by 4.5 percentage points, from the current 35% to 30.5%. However, Rep. Rangel’s proposal would also curtail certain corporate tax benefits in order to pay for the rate reduction; these benefit reductions include repealing the domestic production activities deduction and the worldwide allocation of interest, limiting income tax treaty benefits for certain tax deductible payments, and imposing additional limitations on U.S. corporations deferring income through controlled foreign corporations.

Separately, the Fair Tax Act of 2009 (released January 6), if enacted, would abolish the federal income and payroll taxes and estate and gift taxes, and enact a national sales tax. The sales tax would be imposed on the use or consumption in the U.S of taxable property and services. We believe that this type of fundamental tax reform will not be enacted.

4. Enhanced Individual Tax Credits

Earned Income Tax Credits

Separately from the Obama stimulus plan, the Strengthen the Earned Income Tax Credit Act of 2009 (S. 24) includes changes in the earned income credit, for taxable years beginning after 2008, to reduce the marriage penalty by increasing the addition of the joint return’s phase-out amount to $5,000 from $3,000; increase the earned income credit percentage for families with 3 or more children to 45% from 40%; increase the credit percentage for individuals with no qualifying children from 7.65% to 15.3%; and increase the earned income amount from $4,220 to $7,250. The credit would be phased-out for earned income over $14,500. The bill also would eliminate the disqualified investment income test.

As part of President Obama’s submission of his first budget commencing in February 2009, he has stated he will include an expansion of the earned income tax credit available to single workers and families with three or more children. Further, President Obama is expected to increase the benefits available to noncustodial parents who fulfill their child support obligations and extend the phase-out for joint filers with children.

“Making Work Pay” Tax Credit

The goal of the “Making Work Pay” tax credit proposed by President Obama is to provide a refund to each individual equal to his or her Social Security tax payment on the first $8,100 of wages for 2009 and 2010. Effectively, the credit would equal 6.2% of up to $8,100 of earnings, resulting in a maximum credit of $500 for single persons and $1,000 for couples. The “Making Work Pay” tax credit would phase out as income exceeds $75,000 for single filers and $150,000 for couples.

Work Opportunity Tax Credit

The House Democrats’ January 15 plan includes an expanded work opportunity tax credit for disconnected youth and unemployed recently discharged veterans.

Dependent Care Tax Credit

President Obama made the expansion of access to child care a critical issue in helping individuals re-enter, and remain in, the workforce. The Obama administration would reform the Child and Dependent Care Tax credit by extending the income range over which the credit phases down, making it refundable for taxpayers not able to use it as a tax credit, and allowing low-income families to receive up to a 50% credit on the first $6,000 of child care expenses. Under current law, in 2008 credit amounts decrease as income rises above $75,000.

Education Tax Credits

The House Democrats’ January 15 outline would simplify education credits by providing a $2,500 credit for the first four years of higher education expenses, increasing income limitations, and making up to 40% of the credit refundable to taxpayers not able to use it as a tax credit.

Separately, Sen. Charles Schumer (D-NY) is confident a new tuition tax credit proposal (the American Opportunity Tax Credit) will become part of a final economic stimulus plan. This proposal would allow parents who earn up to $140,000 to claim a $4,000 refundable credit per child annually for four years on their jointly filed tax return. This credit also would allow students or their parents to include the cost of textbooks, which is not allowed in current deductions or credits. The proposed credit would replace the Hope credit and Lifetime Learning credit available currently (the Hope credit reduces a taxpayer’s tax bill by up to $1,800 per year for a child’s first two years of college, and the Lifetime Learning credit lowers a taxpayer’s tax bill by up to $2,000 annually). Recipients of this credit would be required to provide 100 hours of public service a year, either during the school year or over the summer months.

First-time Home Buyer’s Tax Credit

Legislation enacted in 2008 provided a $7,500 tax credit for first-time homebuyers buying a home between April 2008 and June 2009, and is designed to be repaid by taxpayers without interest to the Internal Revenue Service over a 15-year period. In addition, a standard deduction (for those who do not itemize) of up to $500 ($1,000 for joint filers) is available for the 2008 tax year for property taxes paid.

Senate Finance Committee Chair Max Baucus (D-MT) has suggested that Finance Committee members discuss a variation of a tax credit to promote home purchases and stabilize the continuing decline of home values. Separately, the Treasury’s Taxpayer Advocate Nina Olson has recommended a deduction for a decline in a home’s value, subject to limitation. The House Democrats’ January 15 plan also includes removal of the repayment requirement for the credit, for homes purchased after 2008 and by the end of June 2009.

5. Retirement Savings Proposals

On January 14, 2009, House Republicans released their summary of an alternative stimulus package (H.R. 470) which would provide targeted relief to middle-income families and small businesses, with provisions designed to not burden future generations. Among the proposals in H.R. 470 is the permanent repeal of required distributions attributable to individual retirement accounts. Under the Worker Retiree and Employer Recovery Act of 2008, the minimum required distributions from IRAs and defined contribution plans were temporarily suspended for 2009 (not for 2008 required minimum distributions to be taken in 2009), but scheduled to continue in 2010. The H.R. 470 proposal would permanently suspend the minimum distribution requirements, but only for IRAs.

If enacted, this legislation would provide an additional benefit to taxpayers by allowing them to rollover qualified plan monies into an IRA, thereby avoiding undesired required distributions while also reducing related income tax liabilities.

In addition, H.R. 470 provides that distributions from IRAs would be tax-free and not subject to any withdrawal penalty. This provision would help those individuals facing foreclosure and other financial emergencies to access IRA funds without an income tax liability or distribution penalty imposition.

6. Estate Tax Repeal Proposals

President Obama is on record as desiring to retain the estate tax and freeze the applicable estate exclusion amount of $3.5 million, while maintaining the current top tax rate of 45%. The legislation may include a provision making the $3.5 million exclusion amount portable between spouses. Such a provision would allow the surviving spouse to utilize the unused proportion of the decedent spouse’s applicable exclusion amount. (It should be noted that many states do not conform to the Federal estate tax rules.)

On January 9, 2009, U.S. Rep. Earl Pomeroy (D-ND) sponsored H.R. 436 which would retain the estate tax with a $3.5 million exclusion. The Pomeroy proposal would also impose a 5% surcharge on estates valued over $10 million. H.R. 436 was referred to the House Ways and Means Committee and is currently awaiting Committee member review.

7. Expanded Corporate Expensing and Loss Carryback Provisions

Increased Expensing Provisions

President Obama’s stimulus plan includes an extension of the bonus depreciation provision for assets placed in service in 2009. This provision would be an extension of the current law which allows taxpayers to deduct immediately 50% of the cost of applicable assets acquired with depreciable lives of 20 years or less. The bonus depreciation provisions could also be expanded to apply to acquisitions of motion picture films and videotapes during 2009, as was proposed by Senate members in December 2008.

Another current benefit would allow businesses to immediately expense acquired capital assets. An existing provision allows businesses to expense up to $125,000 (subject to a phase-out) of applicable capital acquisitions through 2010; in 2008 Congress temporarily increased, only for 2008, the deductible amount to $250,000 (phased out beginning at $800,000 in capital asset acquisitions). The increased $250,000 deduction amount would be extended to 2009, and is expected to be retroactive to January 1, 2009.

Increased Net Operating Loss Carryback Provision

A corporation is presently allowed to carryback a current year net operating loss (“NOL”) to generate a refund of income taxes if the corporation had income in the previous two years. Some major business trade associations have suggested that many companies will not have had income in 2007 and 2008 in an amount sufficient to absorb losses expected to be generated in 2009; this could also limit the impact of the proposed increased expensing provisions discussed above. President Obama’s stimulus plan would increase the potential NOL carryback period for losses to the previous five years; this would allow the recovery of tax payments made in prior years, which could be applied by corporate taxpayers to operate businesses that are struggling in the current climate.

The House Democrats’ January 15 provisions would exclude companies receiving TARP benefits (for instance Fannie Mae and Freddie Mac) from the increased NOL carryback provision.

House Republican Leader John Boehner (R-OH) has proposed that the NOL carryback period be five years for small businesses, and three years for larger businesses.

8. Pre-Acquisition Losses of Banks

Generally, under current law, if an acquired corporation has an unrealized built-in loss, the ability of the purchaser to utilize the loss against post-acquisition income is limited. However, in IRS Notice 2008-83, the U.S. Treasury announced that any deduction properly allowed after an ownership change to a bank with respect to losses on loans or bad debts would not be treated as a built-in loss. The January 15 plan includes a prospective repeal of this Notice, which would thus limit the use of losses on pre-acquisition bank loans by the acquirer.

9. Energy Provisions

The following provisions were included in the House Democrats’ January 15 plan:

Renewable Energy Production Tax Credit (REPTC)

The REPTC generally provides a tax credit of 1.9 cents per kilowatt-hour of electricity generated by certain renewable energy facilities. The plan includes a multi-year extension beyond 2010 of the tax credit for wind, geothermal, hydro, and bioenergy electricity generation facilities. It also provides a temporary election to claim the investment tax credit in lieu of the REPTC.

Additional Energy Credits

The plan includes research and development tax credits for energy conservation, energy efficiency, and renewable energy research expenditures. It also expands existing credits for refueling property, nonbusiness energy property, residential energy efficiency property, and certain solar energy, geothermal deposit, and fuel cell expenditures.

Energy Bonds

The January 15 provisions would create new tax-advantaged Clean Renewable Energy Bonds and Qualified Energy Conservation Bonds, to promote the financing of renewable energy facilities and energy conservation expenditures.

10. Government Bonds

The January 15 plan would make it easier for financial institutions to invest in municipal bonds. It would also repeal the AMT income inclusion for tax-exempt income from new private activity bonds.

In addition to the provisions for bonds (and tax credits) promoting renewable energy and conservation as noted above, tax-exempt and tax-credit “recovery bonds” would be authorized to spur development in areas with high unemployment.

The January 15 plan also lists a taxable bond option for governmental bonds, which may include a tax credit for purchasers of taxable bonds.

11. Investment and Spending Provisions

Among the spending provisions and consistent with the President’s objectives, the plan released January 15 provides major funding for energy, science, infrastructure, education and healthcare, re-employment and training, and relief for the states.

Specifically, there is a focus on reducing dependence on foreign oil and strengthening efforts directed at doubling renewable energy production and renovating public buildings to make them more energy-efficient. In this regard, $32 billion would be spent to transform the nation’s energy transmission, distribution, and production systems by allowing for a smarter and better electric energy distribution grid and focusing investment on renewable technology. An additional $16 billion would be spent to repair public housing and make key energy efficiency retrofits.

Investments in science and technology would include $10 billion for science facilities, research, and instrumentation, and $6 billion to expand broadband internet access so businesses in rural and other underserved areas can link up to the global economy.

Infrastructure investments would focus on modernizing roads, bridges, transit and waterways: $30 billion would be allocated to highway construction; $31 billion to modernize federal and other public infrastructure with investments that lead to long term energy cost savings; $19 billion for clean water, flood control, and environmental restoration investments; and $10 billion for transit and rail to reduce traffic congestion and gas consumption.

Educational investments would include $41 billion to local school districts through Title I ($13 billion), IDEA ($13 billion), a new School Modernization and Repair Program ($14 billion), and the Education Technology program ($1 billion). An additional $79 billion would be allocated to state fiscal relief to prevent cutbacks to key services, including $39 billion to local school districts and public colleges and universities distributed through existing state and federal formulas. Also, $15 billion would be provided to states as bonus grants as a reward for meeting key performance measures, and $25 billion to states for other high priority needs such as public safety and other critical services, which may include education. Another $15.6 billion would be allocated to increase Pell grants by $500 each, and $6 billion would be incurred for higher education modernization.

Healthcare investments would include $20 billion for health information technology to prevent medical errors, and $4.1 billion to provide for preventive care and to evaluate the most effective healthcare treatments.

To help place unemployed workers, $43 billion would be allocated for increased unemployment benefits and job training, $39 billion would be expended to support those who lose their jobs by helping them to pay the cost of keeping their employer-provided healthcare under COBRA and providing short-term options to be covered by Medicaid, and $20 billion would be allocated to increase the food stamp benefit by over 13% in order to help defray rising food costs.

Relief for the states would include $87 billion for a temporary increase in the Medicaid matching rate and $4 billion for state and local law enforcement funding.

The January 15 plan also provides $430 million to the Small Business Administration for new direct lending and loan guarantee authorities to make loans more attractive to lenders and free up capital.

Any tax advice in this communication is not intended or written by Frank, Rimerman + Co. LLP to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer, or (ii) promoting, marketing, or recommending to another party any matters addressed herein. With this alert, Frank, Rimerman + Co. LLP is not rendering any specific advice to the reader.