After 23 extensions of the previous legislation since 2007, the new FAA Modernization and Reform Act of 2012 became law on February 14, 2012 (Pub. L. No. 112-95). One of the few legislative compromises of the 112th Congress, this legislation extends, through September 30, 2015, the aviation excise taxes (generally at present levels) and expenditure authority of the FAA and provides for a host of new programs, including the modernization of air traffic control. Certain changes were made to the taxing provisions, the most important of which are: (i) fractional aircraft use is now treated as noncommercial aviation for tax purposes through September 30, 2015, subject to a fuel surtax of 14.1 cents per gallon (in addition to noncommercial aviation base fuel tax) that will sunset September 30, 2021, and (ii) small jet aircraft operating on nonestablished lines will no longer be exempt from excise taxes on transportation of persons and cargo.
Payroll Tax Relief Extended
On February 22, 2012, the President signed the Middle Class Tax Relief and Job Creation Act of 2012 (Pub. L. No. 112-96). This law amended the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 to extend through the remainder of 2012 the two percent reduction in employment tax rates for employees and self-employed individuals. The law also eliminated the special rule for 2012 limiting the amount of wages eligible for such tax rate reduction.
The Transportation bill that passed the Senate with bipartisan support in March, S. 1813, contains several revenue provisions, including the enhancement of IRS tax enforcement by the revocation or denial of a passport in the case of seriously delinquent large tax debts, increased levy authority on certain Medicare payments and a provision authorizing certain special measures against foreign jurisdictions and financial institutions to counter efforts to significantly impede U.S. tax enforcement. If passed, this latter provision could increase the pressure on foreign jurisdictions to cooperate in the implementation of the Foreign Account Tax Compliance Act (FATCA). In addition, the Senate bill would impose tax on securities in certain otherwise tax-free reorganizations and an additional one-year delay in the implementation of the worldwide interest allocation rules. The Senate rejected amendments that would extend a number of alternative energy related credits.
It's difficult to say where these provisions will end up: The House and Senate have agreed to a temporary extension of transportation programs through June 1, with a view to negotiating a longer-term reauthorization by then through a conference committee. With House Republicans unable to muster a majority for an alternative to the Senate bill, on April 18, the House passed another short-term extension to September 1, which the Senate has amended with its bill, and requested a conference and appointed conferees. Odds that the chambers can reach a compromise on long-term reauthorization by June 1 are not good: Transportation Secretary LaHood recently said a long-term bill won't happen before the November elections -- the environment in the House is too partisan. However, transportation programs are popular on both sides of the aisle and important to many swing districts, so the bill can't be written off just yet. Any final compromise is expected to look much more like the Senate bill since they go into conference with the stronger hand, having passed a longer term reauthorization. Stay tuned for the next chapter in this saga.
The $900 Billion Question: Re-enactment of "Extenders"?
For many years, Congress has increased its practice of enacting legislation scheduled to expire within a few years of enactment. The number of these "extenders" has ballooned from approximately 57 provisions expiring from 2002 through 2010, to 132 expiring between 2011 and 2022. The provisions include: tax incentives for business, energy and individual investment, many of which have been extended multiple times; all of the 2001 and 2003 tax cuts -- including significant ordinary and capital gains rate cuts, suspension of certain deduction limitations; estate and gift tax rates and exemptions; payroll tax relief (as described above); alternative minimum tax relief (indexing the exemption); aviation and highway taxes; and disaster relief provisions. Lately, every extension is an occasion for partisanship.
Most of these extenders expired in 2011 or will expire by December 31, 2012, and it is not clear if Congress will reenact these (in whole or in part) in 2012. Expired or expiring business extenders include the research credit, additional first-year depreciation, energy incentives and certain deferral provisions for U.S. multinational corporations. The last broad extension occurred in December 2010 and cost $858 billion over ten years. Some Members have recently suggested that separate determinations should be made on extending each of these provisions. The House Select Revenue Measures Subcommittee has scheduled a hearing on April 26, 2012, to evaluate the extenders against motive's such as cost, effectiveness and job creation. Whether Congress will extend the 2001 and 2003 tax cuts may be heavily influenced by the election results.
If Congress fails to extend the 2001 and 2003 cuts, on January 1, 2013, the income tax rates of ten percent, 25 percent, 28 percent, 33 percent and 35 percent will rise to 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent, respectively (in addition, a marginal 3.8 percent Medicare tax described below will be imposed on net investment income). The maximum rate for long-term capital gains and qualified dividends will rise from 15 percent to 20 percent and 39.6 percent, respectively. In addition, limits will be re-imposed on itemized deductions and personal exemptions, and certain other family incentives, such as marriage penalty relief, child tax credit and the earned income credit, will be cut back. The estate and gift tax top rates and exemption amounts will change from 35 percent and $5,120,000 to 55 percent and $1,000,000, respectively.
Dueling Job Creation Incentive Bills
Efforts to pass new business tax cuts to stimulate the economy are continuing. Last week, on a largely party-line vote, the House approved a $46 billion bill (H.R. 9) to give all companies with fewer than 500 employees a one-year tax deduction equal to 20 percent of their profits. Senate Democrats have proposed their own $26 billion bill (S. 2237) to give companies a temporary tax credit equal to ten percent of the amount they increase their payroll in 2012 over 2011, capped at $500,000. The Senate bill, which could come up for a vote in May, would also extend through 2012 bonus depreciation, i.e. 100 percent expensing, of newly purchased equipment. While the latter provision has bipartisan support, the fact that neither bill is paid for will make it hard to navigate election year deficit politics.
2012 Farm Bill
Work to reauthorize agriculture, food and nutrition programs, including tax provisions such as the conservation easement tax deduction which expired at the end of last year, commences this week in the Senate with markup of a 900-page bill. Among the largest revenue-raising provisions in the 2008 bill were several provisions to offset its cost, including an extension of customs user fees and a change in the estimated tax payment of corporations, together totaling about $10 billion. Such offsets are not expected this time around due to steep cuts of $23 billion or more in farm programs. The House is holding hearings on farm programs and likely will not act unless/until the Senate passes its measure. If past is prologue, a temporary extension of the current law, as happened with the last two reauthorizations, is likely before another five-year bill is enacted.
The Longer Term: Outlook for Comprehensive Tax Reform
While no one can predict what will happen in the 113th Congress commencing in January 2013, momentum has been building during the current Congress for comprehensive tax reform. The Senate and House tax-writing committees have each held a dozen hearings in the current Congress on aspects of tax reform, with more to come. However, this has produced no political or policy consensus, although there have been "dueling" reform bills and symbolic proposals to cap federal revenues at around 20 percent of GDP (thereby forcing tax and spending changes). As with so many other policy decisions, the shape of any tax reform will be driven by the November elections and the budget deficit. Treasury Secretary Geithner said at a hearing earlier this year that in a post-election, lame-duck session, lawmakers will have to "look at how to put in place long-term fiscal reforms. As part of that, we expect them to look at things we can do in the tax system as part of a balanced deficit reduction plan."
The best indicator of what to expect should momentum reach critical mass next year, are the similarities in the plans laid out thus far by the White House and Congressional Republicans (and recent remarks from presumptive Republican Presidential nominee Mitt Romney):
- President Obama's plan, as most recently embodied in his FY 2013 budget proposal and his Tax Reform "Framework," would retain the current "worldwide system"; impose a minimum rate of immediate taxation on income earned by subsidiaries of U.S. corporations operating abroad; broaden the corporate tax base by eliminating many targeted benefits, such as oil and gas tax preferences; make permanent the research and development tax credit; reduce the corporate rate from 35 percent to 28 percent (25 percent for manufacturing); continue most current personal income rates but allow the top two rate brackets to return to 39.6 and 36 percent (from the current 35 and 33 percent); limit the value of various personal deductions, such as charitable contributions, to 28 percent for top earners; and allow total revenues to rise to about 20 percent of GDP.
- The House Republican plan, as embodied in the House-passed FY 2013 budget resolution, H. Con. Res. 112, a.k.a. the "Path to Prosperity" (a.k.a. "Ryan II" after the Budget Committee Chairman Paul Ryan), would ultimately reduce the corporate and top personal income tax rates to 25 percent; replace the other current personal income rates with a single ten percent rate; limit certain deductions for higher income earners, such as mortgage interest, charitable contributions and state and local taxes; and allow revenues to rise to about 18 or 19 percent of GDP. Ways and Means Committee Chairman David Camp has proposed shifting from a worldwide system to a territorial system of international taxation, but has included three options for minimizing the loss of revenue through "base erosion," one of which is the President's proposal to tax excessive income from intangibles held offshore.
- Mitt Romney has yet to produce a comprehensive tax reform plan, but endorsed Ryan II when it was released and supports an across the board cut in marginal income tax rates, including reducing the corporate rate to 25 percent. More recently, he was overheard telling supporters he would eliminate or limit the mortgage-interest tax deduction for second homes for those with high incomes, and probably would do the same for the state income-tax and state property-tax deductions, as reported by the Wall Street Journal. While there are vast differences in the details of these revenue proposals and the spending supported by the policies envisioned in each plan, one can begin to see how a deal could be reached on aspects of tax reform such as broadening the base and lowering at least the corporate rate.
On other aspects, such as the estate tax, dividends and capital gains rates and the top personal rate, the parties seem far apart, with Democrats touting the Buffett Rule (proposed but failing in the Senate as a minimum 30 percent tax on incomes over $2 million) as a new commandment of tax fairness.Until "consensus" develops on the mix of spending cuts and revenues necessary to reduce the deficit (i.e., 60 votes in the Senate for some version of the above proposals or some hybrid thereof), it's hard to see how comprehensive reform gets enacted. With the latest polls showing the country nearly evenly split politically, comprehensive reform post-November may ultimately prove difficult to achieve. But that won't stop the next Congress from trying. An economic collapse in Europe or some other event could change the prevailing political winds, so stay tuned in to future alerts to keep up with the latest developments.
PLANNING FOR UNCERTAINTY
Although the odds are growing longer for major Congressional action prior to the November elections as we draw closer, there is a possibility of significant Congressional action during the "lame duck" period between the elections and the end of 2012. Such action might include the extension of some or all of the extenders, including the 2001 and 2003 tax cuts. In any event, given the deficit, it doesn't appear likely that taxes will go down in 2013 -- at best, they will stay the same as in 2012. Corporations and individual investors with a stake in business tax incentives that are extenders -- as well as other taxpayers -- should keep a watchful eye on Congress and the election results. Individuals who are planning transactions that could trigger income, gains or deductions in either 2012 or later years may wish to consider the possible significant increase in tax rates and deduction limitations beginning in 2013 in weighing their options. Corporations that plan to pay dividends may wish to consider the potential meaningful tax increase on dividends (potentially from current 15 percent rates to 43.4 taking into account the new Medicare tax) in connection with their dividend policy. Individuals should also consider the possible changes in the estate and gift taxes in planning gifts.