On May 11, the Obama Administration released its Fiscal Year 2010 Revenue Proposals (Greenbook), describing the tax law changes the Administration will propose. In addition to allowing the highest ordinary income tax rates to return to pre-Bush levels, and the highest capital gains tax rate to go to 20%, the Administration’s proposals include:
Codification of the Economic Substance Doctrine
The Administration proposes codifying the “economic substance doctrine” and imposing a new penalty scheme for certain transactions that lack economic substance. The economic substance doctrine is a judicial doctrine that denies taxpayers the tax benefits associated with a transaction that lacks economic substance. The codified economic substance doctrine and related expanded 30% penalty would generally apply to transactions entered into after the enactment of the law.
Repeal of LIFO
The Administration proposes repealing last-in, first-out (LIFO) accounting for inventory. LIFO accounting allows a taxpayer computing the value of its inventory and cost of goods sold to treat the most recently acquired goods as having been sold first. It would also repeal the lower of cost or market inventory valuation method. The increased income resulting from the change would be recognized ratably over the first tax year the change is applicable and the following seven tax years.
Taxation of Carried Interest as Ordinary Income
The Administration proposes taxing income or gain from a service provider’s carried interest or profits interest in a partnership as ordinary, self-employment income, not capital gain.
Expansion of NOL Carryback Period
The Greenbook proposes an extension of the period that a company can carry back its net operating losses (NOLs) to offset income earned in prior years. Under current law, an NOL generally may be carried back for up to 2 years and may be carried forward for up to twenty years. The Administration proposes extending the carry-back period beyond two years. A bill in the Senate would extend the NOL carryback period for 2008 and 2009 NOLs for all corporations to five years.
Elimination of Capital Gains on Investments in Small Business Stock
Another taxpayer favorable provision would eliminate the capital gains tax for non-corporate shareholders on the sale of stock of certain small business corporations. Current law allows non-corporate shareholders to exclude from taxable income 50% (up to 75% in certain circumstances) of the gain from the sale of stock in certain small business corporations if the stock was originally issued to the shareholder and held for at least 5 years. For capital gain to be excludable, the small business corporation must be a domestic C corporation with $50 million or less in assets on the date it issued the relevant stock. The C corporation must be engaged in an active business and may not be (i) a services corporation where the principal asset is the reputation or skill of employees, (ii) a financial services, leasing, banking or other similar business, (iii) a business involving the production or extraction of an item subject to depletion or (iv) a hotel, motel, restaurant or similar business.
The Administration proposes to expand the exclusion of gain attributable to the sale of small business stock to 100% of gains. The limitations regarding the amount of gain, holding period for the stock and business of the corporation would not change.
Make the Research and Experimentation Tax Credit Permanent
The Research and Experimentation (R&E) Tax Credit provides a credit for a portion of a taxpayer’s increased R&E expenditures. The R&E Tax Credit is a temporary credit, the availability of which has been regularly extended by Congress. Under the proposal, the R&E Tax Credit would be made permanent.
Estate and Gift Tax Proposals
The Administration is proposing to enact further restrictions on valuation discounts, by eliminating lack of control discounts. It is unclear whether or how marketability discounts would be similarly limited. Under the Pomeroy Bill (H.R. 436), valuation discounts for most, if not all, passive investment entities, such as family LLCs and family limited partnerships, would be reduced or eliminated.
The Administration would also make grantor retained annuity trusts (GRATs) much less attractive to older and unhealthy taxpayers by requiring GRATs to have a minimum term of 10 years. Although the minimum term would not prevent “zeroed-out” GRATs, it would increase the risk the GRAT will fail because the grantor must survive the GRAT’s term to be effective.