The President's Budget Could Hurt Your Tax Bill

Not surprisingly, Barack Obama’s tax policy objectives have been a moving target. During the campaign we heard one thing. Let's call it version 1.0. Of course, campaign promises were tempered by reality soon after the election was over. The dire state of the economy dictated that the newly-elected president's planned tax increases for individuals could not be implemented immediately.

In fact, the multitude of tax changes in the Obama-sponsored American Recovery and Reinvestment Act of 2009 (better known as the Stimulus Bill), unveiled in February, were almost all pro-taxpayer. That was version 2.0, and many taxpayers breathed a sigh of relief.

But those taxpayers shouldn't get too comfortable, because the target is still moving. The administration’s proposed budget for the 2010 fiscal year reveals some of the president’s longer-term tax policy goals. I refer to this as version 3.0 -- and some of you may not like it.

Here’s a breakdown of the tax changes proposed in Obama's budget that would have the most impact on you.

As promised (maybe threatened is a better word) during the campaign, the Obama budget calls for unwinding the Bush tax cuts for individuals in the top two brackets, starting in 2011. The current 33% and 35% federal income tax rates would be replaced with the pre-Bush administration rates of 36% and 39.6%, respectively. This change would affect married joint-filing couples with incomes above $250,000 and unmarried individuals with incomes above $200,000. The rate hike is projected to raise about $340 billion in tax revenue between 2011 and 2019.

Obama also wants to restore two dreaded phase-out rules that can wipe out: (1) part or all of a higher-income individual’s personal exemption deductions and (2) up to 80% of the most common types of itemized deductions. These changes were also proposed during the campaign and would take effect in 2011. Married joint-filing couples with incomes above $250,000 and unmarried individuals with incomes above $200,000 would be impacted. The restored phase-out rules are expected to raise about $180 billion in 2011-19.

Starting in 2011, the Obama budget includes a change that would effectively allow only a 28% tax benefit for itemized deductions claimed by individuals who are in the new 36% and 39.6% tax brackets. As a result, itemized deductions for these folks could first be cut back by the phase-out rule explained above. Then whatever deductions are left would deliver only a reduced tax-saving benefit of 28% instead of the expected 36% or 39.6%. This change is projected to raise about $320 billion between 2011 and 2019.

The Obama budget proposed to leave the current taxpayer-friendly federal income rate on long-term capital gains and dividends in place for all taxpayers except those in the highest two tax brackets. For those unlucky folks, the maximum rate would go up to 20%, from the current 15%. This change would take effect in 2011. The rate hike is projected to raise about $120 billion between 2011 and 2019.

Obama's budget requests the continuation of the current policy, which calls for increases in the alternative minimum tax (AMT) exemption amounts each year to account for inflation.

The budget calls for the continuation of the current federal estate tax exemption amount of $3.5 million per person and the current maximum estate tax rate of 45%.

Under current rules, you can use most personal federal income tax credits (such as the higher education credits and the dependent care credit) to offset up to 100% of your federal income tax bill. But the credits end there. In contrast, so-called “refundable” credits are called that because the government pays them out in cash to eligible individuals after their tax bills (if any) have been reduced to zero. In other words, any refundable credits left over after your tax bill has been completely wiped out are sent to you in cash. To the extent this happens, refundable credit payments are basically disguised welfare. The Obama budget includes the following proposals for refundable personal credits.

Making Work Pay Credit: The current refundable credit of up to $400 for working singles and $800 for couples would be continued, which would cost the Treasury about $540 billion between 2011 and 2019.

Child Credit: Current liberalizations of the child credit, which make it a wholly- or partially-refundable credit for more taxpayers, would be continued at an estimated cost of about $70 billion for the years 2011 to 2019.

American Opportunity Credit: The current partially-refundable credit of up to $2,500 to cover tuition and course material costs during the first four years of college would be continued, which would cost about $75 billion for the years 2011 to 2019.

Earned Income Credit: The Obama budget calls for providing increased credits to qualifying married couples and families with three or more children. Doing so would cost the Treasury about $30 billion between 2011 and 2019. 

Add all these things up, and they amount to about $1.6 trillion worth of tax changes for 2011 through 2019. So it's important for taxpayers to be informed and equally important to let your congresspersons and senators know how you feel about the proposals.