The Debt Ceiling Debate & Possible Tax Law Changes

Unless you have been living under a rock, or just wishing you did, you could not miss the recent political debates over the debt. Now that the inital dust has settled, we need to take a much closer look at what this could mean to current tax law and its impact on our planning.

On August 2nd, Congress passed and the President signed into law S. 365, the “Budget Control Act of 2011.” The initial $1 trillion round of deficit reduction over fiscal years 2012 through 2021 doesn’t include revenue hikes, but the second, $1.5 trillion round of deficit reduction over the same years may feature fundamental tax changes as part of the work-product of the bill’s newly established Joint Select Committee on Deficit Reduction (JSC).

The JSC’s goal is to reduce the deficit by an additional $1.5 trillion over fiscal years 2012 through 2021, and in finding these savings, its duties are to “provide recommendations and legislative language that will significantly improve the short-term and long-term fiscal imbalance of the Federal Government.” Subject to great political debate and contraversy, this has set the stage for the next round of tax reform discussions (or lack there of).

It is hard to say what, if anything, the JSC might recommend by way of tax changes. Democrats are pushing for increased taxes (particularly on the “wealthy” and corporations), while Republicans are looking for savings through spending cuts and not through increased tax revenues.  Looking to past proposals the following items will certainly be part of these heated debates:

  • Businesses may have to give up costly tax breaks, such as bonus depreciation, the domestic production activities deduction  and the use of the last-in, first-out (LIFO) inventory accounting method.
  • Industries (such as oil and gas) may have to give up some of their tax preferences. In return, corporations may wind up with a modestly lower top rate.
  • In the international arena, a territorial tax regime may be adopted, there may be a repatriation holiday to induce multinationals to bring home overseas profits (something I strongly advicate), and there may be crackdowns on transfer pricing tax strategies.
  • There could be a new round of loophole closers, such as a crackdown on “carried interest.”
  • Individuals may find cutbacks in key tax breaks, such as the mortgage interest deduction, in exchange for flattened and lowered tax rates.
  • Other issues the JSC will have to deal with include: the post-2012 expiration of the Bush-era income tax cuts (including the current rate schedules, and low tax rates for long-term capital gains); and the expiration of the Bush-era rules for estate and gift taxation, and the transfer tax rules in the 2010 Tax Relief Act, effective for estates of decedents dying, gifts made, or generation-skipping transfers made after Dec. 31, 2012.

The Budget Control Act of 2011 carries extremely aggressive targets that Congress and the JSC are supposed to meet. Basically, legislation by December 23rd.  Since the time to enact legislation is so short, the JSC may lean heavily on earlier tax proposals, such as those made earlier this year by the President’s Fiscal Commission, the Debt Reduction Task Force, or the bipartisan “Gang of Six.”

If a majority of the JSC members fail to approve a report and legislative language, a sequestration process (i.e., across-the-board reductions) must be implemented, with annual cuts starting in 2013. The cuts will be split 50-50 between defense and domestic spending.

The Administration has said that if the JSC doesn’t approve a report, or if Congress fails to pass the JSC’s recommendation, nearly $1 trillion of deficit reduction would be achieved anyway, by letting the Bush-era tax cuts expire at the end of 2012. The threat of a Presidential veto of an extension of the Bush-era tax cuts would, according to the Administration, help force a balanced deficit reduction (i.e., with tax increases and spending cuts) .

Tax Planning Implications

In 2010, businesses and individuals weren’t certain what tax rules would apply to them for 2011 and 2012 until December 17, when the 2010 Tax Relief Act was signed into law. That pattern of uncertainty until the very last minute is highly likely to be repeated again this year, making year-end tax planning, and tax planning for a longer horizon, a guessing game at best until at least the end of this year.

If the JSC approves recommendations that include comprehensive tax reform, they are not likely to begin to go into effect until 2013. If that’s the case, Congress will still need to address the host of tax breaks set to expire at the end of this year under current law (such as the research credit, the work opportunity tax credit, and the above-the-line deduction for qualified tuition and related expenses). Also, without yet another “patch,” the higher alternative minimum tax (AMT) exemptions and ability to offset AMT with personal credits will both expire at the end of this year.

If the JSC can’t report out a recommendation, or Congress doesn’t pass it, then the extenders would still have to be dealt with late this year or early the next. And in 2012, there would be yet another bruising battle over the Bush-era tax cuts that are scheduled to expire at the end of 2012 under current law.

Until we get a better sense of where the JSC is going, we need to sit tight.  We will hold most of 2012 planning strategies until much closer to the end of the year.

If you have any questions regarding pending legislation or its impact on your year end tax planning, please do not hesitate to contactus.

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