United States: President Tweaks Tax Vision In 2013 Budget

The Obama administration submitted a budget proposal on Feb. 13 with trillions of dollars in proposed tax changes. The tax platform in the budget proposal is largely an amalgamation of provisions from earlier legislative initiatives and previous budgets, but it does include several significant new proposals affecting high-income individuals and multinational taxpayers.

The budget retains the president's long-held position that the 2001 and 2003 tax cuts should only be extended for those with incomes below $200,000 for single filers and $250,000 for joint filers. However, this year's budget also proposes to return the top dividend tax rate to 39.6 percent. The budget last year proposed preserving the equivalent treatment of capital gains and qualified dividends, and increasing the top rate from a 15 percent rate to just 20 percent.

New revenue-raising provisions include four international provisions and two provisions aimed at transfer tax planning. The budget also includes the new "insourcing" tax incentives the president proposed during this year's State of the Union address, but the Treasury explanation (traditionally called the "Greenbook") does not include many additional details on how the provisions would operate.

Overall, the Treasury estimates the budget proposals would cut taxes by $2.81 trillion against a current law baseline that assumes all expiring tax provisions (like the 2001 and 2003 tax cuts) expire as scheduled. Using a baseline that assumes the 2001 and 2003 tax cuts are made permanent, along with current alternative minimum tax (AMT) relief and estate and gift tax rules, the White House estimates the president's tax platform will raise $1.69 trillion.

The budget also provides new information on the principles for tax reform the president outlined during this year's State of the Union address. In particular, the budget clarifies that a proposal requiring taxpayers with incomes exceeding $1 million to pay a minimum effective tax rate of 30 percent is designed to replace the current law AMT.

The White House submits a budget to Congress each year, and its recommendations are not binding. The 2013 budget contains a few less controversial provisions — like an extension of bonus depreciation, AMT relief and the "extenders" — that are likely to be considered by Congress. But most of the tax provisions were proposed in previous years and were not seriously considered by Congress. They remain unlikely to advance in 2012. With Republicans controlling the House, the bulk of the tax proposals should be viewed in the context of the campaign as positions that stake out the president's tax platform.

The major tax provisions in the budget are summarized in the following.

TAX REFORM

In addition to the tax proposals offered in the context of the current tax regime, the budget expands on five principles for tax reform outlined by the president in September. The budget does not submit these as individual tax proposals. They are meant to be considered only as principles taken together in a tax reform plan. The principles, as outlined in the budget, call for tax reform that:

• lowers both individual and corporate tax rates and creates fewer tax brackets,
• limits tax benefits for individuals with $1 million in income,
• cuts the deficit by $1.5 trillion,
• increases job growth, and
• creates a new AMT regime imposing a 30 percent effective rate on those with $1 million in income.

The budget indicates the administration will release a long-awaited Treasury tax reform paper later this month as a roadmap for corporate tax reform focused on increasing job growth in the United States. The budget also provides new information on the president's so-called "Buffet rule," named for investor Warren Buffet. The principle holds that taxpayers with incomes of at least $1 million should pay no less in taxes than middle-class families pay. The budget proposes to fulfill this principle with a mechanism to impose a 30 percent effective tax rate on individuals with at least $1 million in income. The budget clarifies that this regime would be meant to replace the current AMT, but does not otherwise provide details on the mechanism for the new minimum tax.

2001 AND 2003 TAX CUTS

As in previous years, the budget proposes to permanently extend the 2001 and 2003 tax cuts on income below $200,000 for single filers and $250,000 for joint filers (these thresholds would be indexed for inflation occurring since 2009). Without action, the tax cuts will expire at the end of 2012. The proposed extension includes the preservation of:

• the $1,000 child credit,
• marriage penalty relief, and
• ordinary income tax brackets up to the 28 percent bracket, including the expanded 10 percent bracket.

However, the budget generally proposes to roll back the tax cuts for income exceeding the threshold of $200,000 for single filers and $250,000 for joint filers, effective for 2013. The 33 percent bracket would revert to 36 percent beginning at a taxable income level calculated by subtracting the standard deduction and personal exemptions from these thresholds. The current 36 percent bracket would revert to 39.6 percent.

The administration is again proposing a top rate of 20 percent on most capital gains (the current rate is 15 percent) for taxpayers who incomes exceed the high-income thresholds, effective in 2013. This would also include the repeal of a provision allowing an 18 percent rate for property held at least five years that is scheduled to return when the 2001 and 2003 tax cuts expire. The budget makes a major reversal from last year and proposes to allow dividends that fall into the top two tax brackets to be taxed as ordinary income with a top rate of 39.6 percent. The top dividend rate is currently 15 percent, and the president had previously proposed a top rate of 20 percent.

In addition, the budget proposes to reinstate the personal exemption phase-out (PEP) and the "Pease" phase-out on itemized deductions for taxpayers with incomes exceeding the $200,000 and $250,000 thresholds. These changes would be effective beginning in 2013.

GENERAL BUSINESS INCENTIVES

Research credit

The budget proposes to make the existing research credit permanent and to increase the alternative simplified credit rate from 14 percent to 17 percent, effective for research costs paid or incurred after 2011.

Credit for 'insourcing'

The president is proposing a new 20 percent general business credit for the otherwise deductible expenses incurred in connection with "insourcing" a trade or business, effective for expenses occurred after enactment. The Treasury description defines insourcing as reducing or eliminating a trade or business (or line of business) currently conducted outside the United States and starting or expanding the same trade or business within the United States to the extent this action results in U.S. jobs. The cost of severance pay and other assistance to displaced workers in the foreign jurisdiction would not be eligible for the credit.

Section 199 domestic production activities deduction

The president is proposing to reform the Section 199 domestic production activities deduction by narrowing the types of activities that qualify and increasing the deduction rate for the remaining activities. Currently, Section 199 generally allows a 9 percent deduction on qualified production activities.

The proposals would exclude oil and gas production (which is already limited to a 6 percent deduction), other hard mineral fossil fuels (coal) and "certain other nonmanufacturing activities." No other information on additional excluded activities was provided, except that the Treasury maintains that the current credit applies to a "broad range of activities beyond core manufacturing activities." The savings from narrowing the credit would be used to increase the deduction rate by an unspecified amount for most activities, while increasing the deduction to "approximately" 18 percent for "certain advanced technology property." The changes are proposed to be effective for tax years beginning after 2012.

100 percent bonus depreciation

The president is proposing to extend 100 percent bonus depreciation for one year to cover property placed in service in 2012 (2013 for certain aircraft and property with long production periods). Under current law, property placed in service in 2012 is eligible for only 50 percent bonus depreciation. The ability to monetize AMT credits in lieu of bonus depreciation would be available during the extension period. Property placed in service after 2012 would be depreciated using normal rules, as under current law.

QSB stock exclusion

The budget proposes to make permanent the 100 percent exclusion for gains on qualified small business (QSB) stock issued after Sept. 27, 2010, and held for at least five years. The budget also proposes to extend the rollover period from 60 days to six months for QSB stock acquired after 2011. Additional reporting requirements will be provided to ensure compliance.

New credit for manufacturing in areas affected by job losses

This proposal would create a new credit program to support investments in communities that have suffered a "major job loss event," described as a military base closure or reduction or closure of a major employer that results in a "long-term mass layoff." Similar to the new markets tax credit and Section 48C advanced energy manufacturers credit, taxpayers would have to apply for a limited credit allocation. The president is proposing a $2 billion yearly allocation in 2012, 2013 and 2014.

New job creation credit

The budget proposes a temporary employer credit equal to 10 percent of the amount the employer's 2012 eligible wages exceed its 2011 eligible wages, up to a maximum credit of $500,000 per employer. Eligible wages would be those subject to OASDI (old age, survivors and disability insurance) taxes (up to $106,800 per employee in 2011 and $110,100 in 2012). Self-employment income would not count. All corporations that are members of a controlled group would be treated as a single employer, and all employees under common control would be treated as employees of the same employer. The credit would be available to both taxable and (under procedures to be provided) tax-exempt employers other than states, political subdivisions or any of their instrumentalities. Public institutions of higher education would be eligible for the credit.

Build America bonds

The budget proposes to make permanent the Build America bond program and expand the list of eligible governmental capital projects. The subsidy rate would be reduced from 35 percent to 30 percent for bonds issued through 2013, and to 28 percent for bonds issued in later years.

Start-up expenditure expensing

The budget proposes to permanently increase the amount of start-up expenditures that can be deducted from $5,000 to $10,000, effective for tax years beginning after enactment. The deduction would be phased out dollar-for-dollar where start-up expenditures exceed $60,000.

Business 'extenders'

The budget proposes extending through 2013 a number of tax provisions known as "extenders," which expired at the end of 2011, including:

• Subpart F "active financing" and "look through" exceptions,
• the treatment of certain dividends of regulated investment companies (RICs),
• the treatment of RICs as qualified investment entities under Section 897,
• incentives for biodiesel and certain other alternative fuels (not including grain- based ethanol), and
• special 15-year recovery periods for qualified leasehold improvements and qualified restaurant and retail property.

ENERGY PROVISIONS

Energy production and property credits and grants

The budget would extend the rules allowing taxpayers to elect a grant in lieu of a tax credit for certain energy property and energy facilities, provided construction begins before 2013 and the property is placed in service before 2013. For property and facilities placed in service after 2012 and before the credit termination date, where construction begins before 2014, a refundable credit would replace the grant. The budget proposes extending the credit termination date for large wind property by one year, to Jan. 1, 2014. The credit termination date would continue to be Jan. 1, 2014, for facilities and Jan. 1, 2017, for most other kinds of energy property.

New $5 billion Section 48C allocation

The president is again proposing to revive the 30 percent Section 48C credit for investment in property used to manufacture renewable energy equipment with a new allocation of $5 billion. The 2009 stimulus bill created the credit but with a one-time allocation of only $2.3 billion.

Replacement for the plug-in electric vehicle credit

The president is proposing to replace the Section 30D plug-in electric drive motor vehicle with a broader credit for vehicles that operate on alternatives to petroleum using technology currently not in wide use (to be determined by the Treasury and the Department of Energy), as long as the technology exceeds the footprint-based target miles per gallon gasoline equivalent by 25 percent. The credit would be based on the vehicle's efficiency and would be capped at $10,000, and phase out from 2017 to 2019.

Credit for alternative fuel heavy vehicles

The budget proposes a new credit for alternative fuel vehicles weighing more than 14,000 pounds equal to 50 percent of the incremental cost of the vehicles compared to the cost of comparable diesel or gas vehicles. The credit would be capped at $25,000 for vehicles weighing up to 26,000 pounds and $40,000 for vehicles weighing more than 26,000 pounds. The credit would be allowed for vehicles placed in service from 2013 to 2018.

Energy-efficient commercial building credit

For expenditures in 2013, the budget proposes to replace the existing $1.80-per-square- foot deduction for property expenditures for energy-efficient commercial buildings with a credit equal to the cost of certain energy-efficiency property, subject to an overall credit cap of up to $1.80 per square foot. Special rules would be provided to allow the credit to benefit a real estate investment trust (REIT) or its shareholders.

INCENTIVES TO PROMOTE REGIONAL GROWTH

New markets tax credit

The budget proposes extending the new markets tax credit with an allocation of $5 billion for 2012 and another $5 billion for 2013. As with the expired new markets tax credit, the credit would be taken over seven years by taxpayers making qualified equity investments in qualified community development entities supported by the allocation. The new markets tax credit would be allowed to offset the AMT, effective for qualified equity investments made after 2011.

Growth zone incentives

The budget proposes the establishment of 20 "growth zones" (14 urban and six rural), to be chosen through a competitive application process based primarily on the strength of each applicant's "competitiveness plan" and its need to attract investment and jobs. For 2014 through 2018, (i) an employment credit equal to 20 percent of the first $15,000 of wages paid a qualifying growth zone resident (10 percent if employed outside of the zone) would be available and (ii) 100 percent bonus depreciation would be available for new property placed in service within the zone.

State and local bond refunding

The budget proposes the enactment of a general Code provision that would authorize refunding of all state and local bonds if the refunding does not increase the amount of principal or lengthen the weighted average maturity of the refunded bonds.

Low-income housing credits

The budget proposes a series of changes to reform and expand the low-income housing tax credit. These include proposals to allow REITs that receive low-income housing tax credits to designate an aliquot portion of their dividends as tax-exempt, to establish new criteria allowing for a wider range of tenants in rent-restricted units and to provide a "basis boost" for a limited number of projects with federal investment protection designation.

Other incentives

The budget proposes additional incentives to benefit the transportation infrastructure in or connecting to the New York Liberty Zone. The budget also includes proposals that would modify the rules applicable to Tribal Economic Development Bonds.

GENERAL BUSINESS REVENUE RAISERS

LIFO repeal

The budget proposes the repeal of the last-in, first-out (LIFO) method of accounting, effective for tax years beginning after 2013. Taxpayers would be required to include any LIFO reserve in income ratably over 10 years.

LCM repeal

The budget proposes to prohibit the use of lower-of-cost-or-market (LCM) and subnormal goods methods, effective for tax years beginning after 2013. Any Section 481(a) adjustment resulting from an accounting method change away from these methods would be included in income ratably over a four-year period from the year of the change.

Deny deductions for outsourcing

This provision would disallow deductions for expenses related to moving operations overseas, which is defined by inverting the definition of "insourcing" for purposes of the new credit on moving operations back to the United States (discussed previously). The provision appears to be based on previous Democratic legislation that would have denied deductions for expenses related to "offshoring transactions" — defined as the reduction or elimination of the operation of a trade or business in the United States in connection with the startup or expansion of such trade or business abroad. The provision is proposed to be effective for costs incurred after the date of enactment.

Carried interest

The budget again includes a broad proposal to change the taxation of "carried interest" in certain partnerships. The proposal generally follows the approach taken in previous budgets but includes refinements that limit the proposal to carried interests in investment partnerships. Interests granted in primarily operating partnerships would not be affected.

Effective in 2012, income and gain attributable to an "investment services partnership interest" would be taxed as ordinary income and subject to self-employment tax. An investment services partnership interest would be any interest in an investment partnership held by a person who provides services to a partnership that is not attributable to "invested capital." Invested capital is money or property contributed to the partnership for an interest that is allocated capital in the same manner as other capital interests held by partners who do not hold an investment services partnership interest. Broad anti-abuse authority is contemplated, particularly in identifying nonpartnership interests that are the equivalent of an investment services partnership interest.

Other partnership provisions

The budget includes a proposal designed to prevent the duplication of losses where a partner transferee is allocated a substantial loss but the partnership does not itself have a substantial built-in loss, effective for sales and exchanges after the date of enactment. The budget also includes a proposal limiting a partner's deduction for its distributive share of expenditures that are not deductible or chargeable to a capital account of the partnership only to the extent of basis, effective for tax years beginning on or after the date of enactment.

Deny deduction for punitive damages

No deduction would be allowed for the payment of punitive damages upon judgment or settlement of a claim, and any recovery of such damages through insurance would be required to be included in income, effective for damages paid or incurred after 2013.

Worker classification

This proposal would make several changes to tighten the rules for classifying workers as employees or independent contractors. The administration would direct the IRS to issue new guidance on worker classification that includes narrowly defined safe harbors and rebuttable presumptions. The IRS could prospectively reclassify misclassified workers whose reclassification is prohibited under current law. Service recipients would be required to disclose to independent contractors the tax and benefit implications of their classification, and independent contractors could request withholding on their payments. The changes are generally proposed to be effective on enactment, but reclassification would not be effective until the first calendar year beginning at least one year after the date of enactment. A transitional period of at least two years would be provided to independent contractors with existing written contracts establishing their status.

Extension of FUTA

The budget proposes several significant changes to the Federal Unemployment Tax Act (FUTA) tax system:

• Reinstate and make permanent the federal 0.2 percent unemployment surtax, effective for wages paid with respect to employment in 2013 and later
• Raise the FUTA wage base from $7,000 to $15,000 in 2015, and index that amount for inflation in subsequent years
• Reduce the net federal unemployment income tax to 0.37 percent effective in 2015
• Suspend interest payments on state unemployment insurance debt and the FUTA credit reduction for employers in borrowing states in 2012 and 2013

Superfund taxes

The budget would reinstate superfund taxes, including superfund excise taxes and the superfund environment income tax of 0.12 percent of corporate income subject to the AMT in excess of $2 million, effective from 2013 through 2022.

General aviation passenger aircraft depreciation

Effective for property placed in service after 2012, the budget would require airplanes primarily used to carry passengers to be depreciated using a seven-year life. Airplanes primarily engaged in nonpassenger activities such as crop dusting and aerial surveying would continue to be depreciated using a five-year life.

Deduction for easement contributions for golf course

The budget would prohibit a charitable deduction for the contribution of property for a golf course, effective on the date of enactment.

FINANCIAL AND INSURANCE INDUSTRY REVENUE RAISERS

Financial crisis responsibility fee

After scaling back a 2010 proposal to impose a fee based on the liabilities of financial institutions last year, the administration is now expanding the proposal again. The current proposal would apply to financial institutions with more than $50 billion assets, including insured depository institutions, bank holding companies, thrift holding companies, certain broker dealers and companies that control such entities. The fee would be based on the covered liabilities of a financial firm, generally defined as the consolidated risk-weighted assets minus capital, insured deposits and certain loans to small business. The fee rate would generally be 17 basis points, up from the 7.5 basis points proposed last year. The fee is proposed to be effective beginning in 2014.

Forward sales of corporate stock

A corporation that sells its stock forward (agrees to issue the stock in the future) would be required to recognize imputed interest income on the deferred payment, effective for forward contracts entered into after 2012.

Dealers of equity options and commodities

Dealers in commodities, commodities derivatives, securities or equity options would be required to treat income from their dealer transactions as ordinary income. The ability to treat 60 percent of gain as long-term gain would be repealed, effective for tax years beginning after the date of enactment.

Definition of control under Section 249 deduction limit

The budget proposes to change the definition of "control" in Section 249 for purposes of the limitation on an issuer's deduction for a premium paid to repurchase a debt instrument that is convertible into stock of a corporation that is in control of, or controlled by, the issuer. Effective on the date of enactment, certain indirect control relationships would be included.

Corporate owned life insurance

The budget includes a proposal to restrict the use of company-owned life insurance (COLI) by repealing the exception from the pro rata interest rules for employees, officers and directors that are not also 20 percent shareholders, effective for insurance contracts issued after Dec. 31, 2012, in a taxable year ending after that date. Material increases in death benefits and other material changes would be considered to be an issuance of a new contract. Additional covered lives added to a master contract would be considered to be an issuance of a new contract regarding those additions.

Life settlement transactions

The budget proposes to require additional reporting on the purchase of existing life contracts with a death benefit of $500,000 or greater and deny exception to the transfer for value rate for such purchases, effective for sales or assignments after 2012.

Dividends received deduction for life insurance separate accounts

The budget includes a proposal to modify the dividends received deduction for life insurance company separate accounts, effective for tax years beginning after 2012.

Life insurance separate account reporting

Life insurance companies would be required to report policyholder information to the IRS for each contract with a cash value partially or wholly invested in a private separate account (representing at least 10 percent of the value of the account) for any portion of the taxable year.

FOSSIL FUEL REVENUE RAISERS

Inland waterways user fee

The budget proposes to supplement the 20 cents per gallon excise tax on fuel used in commercial waterway transportation with a user fee designed to collect $1.1 billion over the next 10 years.

Coal, oil and gas

The budget proposes to repeal many of the special tax provisions that apply to fossil fuels, coal, oil and natural gas, effective for tax years beginning after 2012. Included are proposals to do the following:

• Repeal the enhanced oil recovery credit
• Repeal the marginal well tax credit
• Repeal percentage depletion for fossil fuels, including coal, oil and natural gas, and require cost depletion to be used to recover any remaining basis
• Require intangible drilling costs to be capitalized and recovered as depreciable or depletable property
• Require exploration and development costs for coal, lignite, oil shale and other hard mineral fossil fuels to be capitalized as depreciable or depletable property
• Require tertiary injectant costs to be capitalized and recovered as depletable property

• Repeal the passive loss exception for working interests in oil and gas properties
• Increase geological and geophysical amortization period from two to seven years for independent oil and gas producers
• Require coal royalties to be taxed as ordinary income instead of capital gains

Oil spill liability trust fund

The budget proposes to increase the financing rate by 1 cent per barrel of domestically produced crude oil or imported petroleum products to a rate of 9 cents per barrel in 2013 through 2016, and 10 cents per barrel thereafter, and to extend the tax to crudes produced from alternative sources such as bituminous deposits or kerogen-rich rock.

INTERNATIONAL REVENUE RAISERS

Defer deduction of interest expense related to deferred income

This proposal is similar to the version in last year's budget. It would defer the deduction of interest expense that is properly allocated and apportioned to stock of a foreign corporation that exceeds an amount proportionate to the taxpayer's pro rata share of income from such subsidiaries that is currently subject to U.S. tax. Under the proposal, foreign-source income earned by a taxpayer through a branch would be considered currently subject to U.S. tax. Thus, the proposal would not apply to interest expense properly allocated and apportioned to such income. Other directly earned foreign source income (for example, royalty income) would be similarly treated. The amount of a taxpayer's interest expense that is properly allocated and apportioned to stock of a foreign corporation would generally be determined under the principles of current regulations, but the Treasury said it would revise existing regulations and propose any statutory changes needed to prevent inappropriate decreases in the amount of interest expense that is allocated and apportioned to foreign-source income.

Deferred interest expense would be deductible in a subsequent tax year to the extent that the amount of interest expense allocated and apportioned to stock of foreign subsidiaries in such subsequent year is less than the annual limitation for that year. Treasury regulations may modify the manner in which a taxpayer can deduct previously deferred interest expenses in certain cases. The proposal would be effective for taxable years beginning after Dec. 31, 2012.

Determining the foreign tax credit on a pooling basis

A version of this proposal was included in last year's budget. The proposal would require a U.S. taxpayer to determine its deemed paid foreign tax credit on a consolidated basis, taking into account the aggregate foreign taxes and earnings and profits of all of the foreign subsidiaries for which the U.S. taxpayer can claim a deemed paid foreign tax credit (including lower-tier subsidiaries described in Section 902(b)). The deemed paid foreign tax credit for a taxable year would be limited to an amount proportionate to the taxpayer's pro rata share of the consolidated earnings and profits of the foreign subsidiaries repatriated to the U.S. taxpayer in that taxable year that are currently subject to U.S. tax. Foreign taxes deferred under this proposal in prior years would be creditable in a subsequent taxable year to the extent that the amount of deemed paid foreign taxes in the current year are less than the annual limitation for that year. The Secretary would be granted authority to issue any Treasury regulations necessary to carry out the purposes of the proposal. The proposal would be effective for taxable years beginning after Dec. 31, 2012.

Tax excess returns associated with transfers of intangibles offshore

This proposal has been fleshed out from last year's budget. The proposal provides that if a U.S. person transfers (directly or indirectly) an intangible from the United States to a related controlled foreign corporation (CFC, a "covered intangible"), certain excess income from transactions connected with or benefitting from the covered intangible would be treated as subpart F income if the income is subject to a low foreign effective tax rate. In the case of an effective tax rate of 10 percent or less, the proposal would treat all excess income as subpart F income and would then phase out ratably for effective tax rates of 10 to 15 percent. For this purpose, excess intangible income is defined as the excess of gross income from transactions connected with or benefitting from such covered intangible over the costs (excluding interest and taxes) properly allocated and apportioned to this income increased by a percentage mark-up. For purposes of this proposal, the transfer of an intangible includes by sale, lease, license or through any shared risk or development agreement (including any cost-sharing arrangement). This subpart F income will be a separate category of income for purposes of determining the taxpayer's foreign tax credit limitation under Section 904. The proposal would be effective for transactions in taxable years beginning after Dec. 31, 2012.

Limit shifting of income through intangible property transfers

This proposal was included in last year's budget. The proposal would clarify the definition of intangible property for purposes of sections 367(d) and 482 to include workforce in place, goodwill and going concern value. The proposal also would clarify that where multiple intangible properties are transferred, the Commissioner may value the intangible properties on an aggregate basis where that achieves a more reliable result. In addition, the proposal would clarify that the Commissioner may value intangible property taking into consideration the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction undertaken. The proposal would be effective for taxable years beginning after Dec. 31, 2012.

Disallow deduction for nontaxed reinsurance premiums paid to affiliates

This proposal was included in last year's budget. The proposal would (1) deny an insurance company a deduction for premiums and other amounts paid to affiliated foreign companies regarding reinsurance of property and casualty risks to the extent that the foreign reinsurer (or its parent company) is not subject to U.S. income tax related to the premiums received; and (2) exclude from the insurance company's income (in the same proportion in which the premium deduction was denied) any return premiums, ceding commissions, reinsurance recovered or other amounts received with respect to reinsurance policies for which a premium deduction is wholly or partially denied.

A foreign corporation that is paid a premium from an affiliate that would otherwise be denied a deduction under this proposal would be permitted to elect to treat those premiums and the associated investment income as income effectively connected with the conduct of a trade or business in the United States and attributable to a permanent establishment for tax treaty purposes. For foreign tax credit purposes, reinsurance income treated as effectively connected under this rule would be treated as foreign source income and placed into a separate category within Section 904. The provision is effective for policies issued in taxable years beginning after Dec. 31, 2012.

Limit earnings stripping by expatiated entities

This proposal was included in last year's budget. The proposal would revise Section 163(j) to tighten the limitation on the deductibility of interest paid by an expatriated entity to related persons. The current law debt-to-equity safe harbor would be eliminated. The 50 percent adjusted taxable income threshold for the limitation would be reduced to 25 percent. The carryforward for disallowed interest would be limited to 10 years, and the carryforward of excess limitation would be eliminated.

An expatriated entity would be defined by applying the rules of Section 7874 and the regulations thereunder as if Section 7874 applied to taxable years beginning after July 10, 1989. This special rule would not apply, however, if the surrogate foreign corporation is treated as a domestic corporation under Section 7874. The proposal would be effective for taxable years beginning after Dec. 31, 2012.

Modify tax rules for dual capacity taxpayers

This was included in last year's budget. The proposal would allow a dual capacity taxpayer to treat as a creditable tax the portion of a foreign levy that does not exceed the foreign levy that the taxpayer would pay if it were not a dual capacity taxpayer. The proposal would replace the current regulatory provisions, including the safe harbor, that apply to determine the amount of a foreign levy paid by a dual-capacity taxpayer that qualifies as a creditable tax. The proposal also would convert the special foreign tax credit limitation rules of Section 907 into a separate category within Section 904 for foreign oil and gas income. The proposal would yield to United States treaty obligations to the extent that they explicitly allow a credit for taxes paid or accrued on certain oil or gas income. The proposal would be effective for taxable years beginning after Dec. 31, 2012.

Tax gain from the sale of a partnership interest on a look-through basis

This is a new proposal that would provide that gain or loss from the sale or exchange of a partnership interest is effectively connected with the conduct of a trade or business in the United States to the extent attributable to the transferor partner's distributive share of the partnership's unrealized gain or loss that is attributable to effectively connected income (ECI) property. The Secretary would be granted authority to specify the extent to which a distribution from the partnership is treated as a sale or exchange of an interest in the partnership and to coordinate the new provision with the nonrecognition provisions of the Code. In addition, the transferee of a partnership interest would be required to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certified that the transferor was not a nonresident alien individual or foreign corporation. The transferee could withhold a lesser amount if the transferor provided a certificate from the IRS establishing the federal income tax liability related to the transfer was less than 10 percent. If the transferee failed to withhold the correct amount, the partnership would be liable for the amount of under-withholding, and would satisfy the withholding obligation by withholding on future distributions that otherwise would have gone to the transferee partner. The proposal would be effective for sales or exchanges after Dec. 31, 2012.

Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment

This is a new proposal that would provide that to the extent a foreign corporation (the "funding corporation") funds a second, related foreign corporation (the "foreign distributing corporation") with a principal purpose of avoiding dividend treatment on distributions to a U.S. shareholder, the U.S. shareholder's basis in the stock of the distributing corporation will not be taken into account in determining the treatment of the distribution under Section 301. For this purpose, the funding corporation and the foreign distributing corporation are related if they are members of a control group within the meaning of Section 1563(a), but replacing the reference to "at least 80 percent" with "more than 50 percent." Funding transactions to which the proposal would apply include capital contributions, loans or distributions to the foreign distributing corporation, whether the funding transaction occurs before or after the distribution. The proposal would apply to distributions after Dec. 31, 2012.

Extend Section 338(h)(16) to certain asset acquisitions

This is a new proposal that would extend the application of Section 338(h)(16) to any covered asset acquisition (CAA) within the meaning of Section 901(m). The Treasury would have the authority to issue regulations necessary to carry out the purposes of the proposal. The proposal would apply to CAAs occurring after Dec. 31, 2012.

Remove foreign taxes from a Section 902 corporation's foreign tax pool when earnings are eliminated

This is a new proposal that would reduce the amount of foreign taxes paid by a foreign corporation if a transaction results in the elimination of a foreign corporation's earnings and profits other than a reduction of earnings and profits by reason of a dividend or deemed dividend, or by reason of a Section 381 transaction. The amount of foreign income taxes that would be reduced in such a transaction would equal the amount of foreign taxes associated with the eliminated earnings and profits. The proposal would be effective for transactions occurring after Dec. 31, 2012.

ADMINISTRATIVE REVENUE RAISERS

The budget proposes a series of administrative changes to the tax laws and expansions in the IRS's reach meant to raise revenue. The provisions include proposals to do the following:

• Require businesses to withhold on payments to contractors if an accurate taxpayer identification number is not furnished
• Require any business filing a Schedule M-3 to file its tax returns electronically
• Grant the IRS authority to require employee benefit plan tax information electronically
• Allow the IRS to levy up to 100 percent of a payment to a Medicare provider to collect unpaid federal taxes
• Allow offset of federal refunds to collect state income tax regardless of where the delinquent taxpayer resides
• Set standards for holding employee leasing companies jointly and severally liable or solely liable for federal employment taxes
• Eliminate the requirements that an initial offer-in-compromise include a nonrefundable portion of the taxpayer's offer
• Expand IRS access to the National Directory of New Hires data for general tax administration purposes, including data matching, verification of taxpayer claims during return processing, preparation of substitute returns for noncompliant taxpayers and identification of levy sources
• Make certain cases of repeated willful failure to file a tax return a felony instead of a misdemeanor
• Treat Indian tribal governments that impose alcohol, tobacco, excise or income or wage taxes as states for purposes of information-sharing
• Create an exception to the three-year statute of limitations for assessment of federal tax liability resulting from adjustments to state or local tax liability
• Change IRS audit procedures for partnerships with at least 100 partners
• Amend taxpayer privacy rules to allow Treasury and IRS employees to identify themselves when contacting third parties in connection with an investigation
• Require taxpayers submitting electronic returns via paper to include a barcode
• Allow the IRS to accept credit and debit card payments directly from taxpayers without processing fees
• Extend IRS disclosure authority related to prisoners filing false returns
• Extend IRS math error authority
• Impose a penalty for failure to comply with electronic filing requirements

TECHNICAL CHANGES

The budget proposes a number of more technical revisions to tax laws identified by the administration as simplification proposals. These proposals would:

• clarify an exception to the rules for recapturing deferred gain from the transfer of stock in an employee stock ownership plan,

• repeal the designation of nonqualified preferred stock as taxable "boot" for certain corporate reorganizations and shareholder exchanges,
• repeal the prohibition on "preferential dividends" for publicly traded REITS and certain other privately held REITs,
• replace the two-tiered excise tax rate structure of 1 percent on 2 percent on the investment income of a private foundation with a single tax rate of 1.35 percent,
• allow small importers and producers of alcoholic beverages to pay alcohol excise taxes on a quarterly or yearly basis without increasing their deferral bond amounts,
• prevent deflationary adjustments for tax items tied to inflation, and
• simplify a number of rules related to tax exempt bonds.

INDIVIDUAL TAX PROVISIONS

Alternative minimum tax

The Treasury uses a budget baseline that assumes future inflation adjustments to increase the AMT exemption amount but specifically mentions that these are not meant to be policy proposals. The Greenbook does not otherwise propose an extension of current AMT relief, but the president offers as part of his principles for tax reform a plan to replace the AMT with a minimum effective tax rate of 30 percent on taxpayers with at least $1 million in income.

Limit the value of tax benefit

The budget includes an expansion of an earlier budget proposal to limit the benefits of itemized deductions to 28 percent for taxpayers with incomes exceeding $200,000 (single filers) or $250,000 (joint filers). The expanded version was unveiled by the president as a revenue offset for a job creation bill offered in September and would expand the limitation on the value of itemized deductions to apply to many above-the-line deductions and exclusions.

Individual extenders

The budget proposes extending through 2013 a number of tax provisions known as extenders, which affect individual taxpayers and expired at the end of 2011, including:

• elective deduction of state and local sales taxes,
• tax-free distributions from IRAs to charities by taxpayers age 70½ or older,
• parity for mass-transit and parking benefits, and
• above-the-line deduction for $250 of teacher expenses.

American Opportunities Tax Credit

The budget proposes to make permanent the American Opportunities Tax Credit and index the caps on creditable tuition and educational expense amounts and phaseout ranges for inflation.

Child care credit

The budget proposes increasing the AGI limit at which the credit begins to phase out from $15,000 to $75,000.

Exclusion for cancellation of qualified principal resident indebtedness

The budget proposes extending the exclusion, scheduled to expire after 2012, through 2014.

Earned income tax credit

The budget proposes to make permanent the expanded earned income tax credit (EITC) for workers with three or more qualifying children. The credit is scheduled to expire after 2012. The budget also proposes to allow taxpayers who would qualify for the EITC without qualifying children to claim the reduced credit available for taxpayers without children even if they live with a qualifying child for whom they do not claim the credit.

EMPLOYER BENEFIT CHANGES

Eliminate minimum distributions on low balance accounts

The budget proposes to exempt taxpayers from requirements to make minimum distributions from IRAs and other tax-favored retirement plan accumulations if the aggregate value of the account does not exceed $75,000 (an increase from the $50,000 threshold in last year's budget). Benefits under a defined benefit plan that are already being paid in an annuity would be excluded. The proposal would be effective for taxpayers who are 70½ on or after Dec. 31, 2012.

Rollover of inherited accounts

The budget proposes a 60-day period in which a nonspouse beneficiary may roll over inherited retirement plan assets or IRA assets into a nonspousal inherited IRA, effective for distributions after 2012.

Automatic payroll deposit IRAs

The budget proposal would require employers to establish an automatic IRA if they have been in business for at least two years, have more than 10 employees and do not sponsor a qualified retirement plan, a simplified employee pension plan (SEP) or a savings investment match plan for employees of small employers (SIMPLE) for their employees. Employee participation would be optional, but any employee who did not provide a written participation election would be automatically enrolled at a default contribution rate of 3 percent, to be funded through payroll withholding. Employees could choose to contribute to a traditional or Roth IRA, with the Roth IRA the default if no choice is indicated. Low-cost, standardized investment alternatives would be provided to relieve employers setting up automatic IRAs from the obligation of choosing such investments.

Employers with no more than 100 employees that offer an automatic payroll deposit could claim a two-year tax credit for the costs associated with the plan of up to $500 for the first year and $250 for the second year. In addition, these employers would qualify for a $25-per-enrolled-employee credit for the first six years, subject to a $250-per-year limit. This proposal is a modest increase over the proposal in last year's budget. Small employers that choose to offer a new qualified retirement, SEP or SIMPLE plan would be eligible for a start-up credit of up to $1,000 per year for four years, an increase over the current $500 three year credit. The provision would be effective after 2012.

Expand the small business health care tax credit

The budget proposes to expand the eligibility for the small business health care tax credit to include employers with up to 50 full-time-equivalent employees (up from 25 under current law), with the credit phasing out between 20 and 50 full-time-equivalent employees. The proposal would also change the phase-out formula and eliminate the requirement that employers make uniform contributions for all employees.

TRANSFER TAX CHANGES

Exemptions and rates

The budget proposes to revert to the transfer tax rules in place in 2009, with a top rate for estate, gift and generations-skipping transfer (GST) taxes of 45 percent (up from 35 percent in 2011 and 2012). The estate and GST tax exemptions would revert from $5 million to $3.5 million, and the gift tax exemption would decrease from $5 million to $1 million. However, the budget does propose to make permanent the current provision allowing portability of unused estate and gift taxes between spouses.

Portability of unused exemption

The budget proposes to make permanent the temporary rule applicable in 2011 and 2012 that allows a surviving spouse to include any unused estate tax exemption of a predeceased spouse in determining the surviving spouse's exemption for gift and estate tax purposes.

Valuation discounts

The administration has again proposed creating an additional category of "disregarded restrictions" under Section 2704 that would be ignored in valuing an interest in a family partnership. In certain circumstances, this would curb the discounts taxpayers can achieve for transfer tax purposes by putting assets in a family-owned business. Broad regulatory authority would be granted to the IRS to determine which restrictions should be disregarded, as well as to create safe harbors to permit taxpayers to avoid these restrictions. The proposal would be effective for transfers of property after the date of enactment, subject to restrictions created after Oct. 8, 1990.

Minimum GRAT term

The administration has again proposed 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. In addition, this year's proposal would require the remainder interest of a GRAT to have a value other than zero.

Consistency in valuations

The proposal would limit the basis of inherited property to the value the property is assigned for estate tax purposes (subject to subsequent adjustments). The executor of an estate would be required to report the valuations used in filing the estate tax return.

Limit duration of generation-skipping transfer tax exemption

This new proposal would terminate the GST exemption of a trust no later than the 90th anniversary of its creation. Currently, an individual can allocate his or her GST exemption to a trust that will last forever if created in certain states, and the trust will never be subject to GST tax. This proposal would subject such a trust to GST tax beginning 90 years after it is created. The proposal would apply to trusts created after the date of enactment and to the portion of a pre-existing trust that can be attributed to additions made to the trust after the date of enactment.

Coordination of income and transfer tax treatment for grantor trust

This new proposal would eliminate the estate planning benefits of what are commonly called "intentionally defective grantor trusts." The proposal would essentially not subject a transfer to a grantor trust to gift tax until there is a distribution from the grantor trust or until the trust ceases to be a grantor trust. To the extent that it is not yet distributed, any amount in a grantor trust at the date of the grantor's death would be subject to estate tax. The proposal would further negate the transfer tax benefits of sales to these trusts.

Extend lien on estate tax deferrals

This new proposal would extend the general estate tax lien that applies to all estate tax liabilities to continue past the normal 10-year period until the expiration of the deferral period elected by the decedent's estate. The proposal seeks to reduce the complexities and costs of requiring additional security once the normal lien period expires, as well as to secure the government's rank among creditors of the estate and its assets.

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