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How the Obama Budget Would Change Your Taxes

President Obama released his budget proposal yesterday, and as expected, it included a number of new provisions that would dramatically change the tax laws once more, with impacts on taxpayers up and down the income scale. The Obama proposal comes as a clear disappointment to anyone who believed that the resolution to the fiscal cliff crisis at the beginning of the year would prove to be the last word on the tax front, but for those who want to see further revenue increases as part of a broader solution to address the national debt, the budget's tax provisions address some of their concerns.

Let's take a look at some of the budget's most important tax proposals and the impact they could have on both individual and corporate taxpayers, as well as the businesses that serve them.

Limited tax savings for itemized deductions and municipal-bond interest
The biggest revenue-raising part of the Obama budget would limit the value of itemized deductions, including the mortgage interest deduction, to 28%. That would impact only high-income taxpayers above the $200,000 and $250,000 income thresholds for single and joint filers, respectively, costing them as much as 11.6 percentage points in tax savings. Because of the high-end focus, the impact on industries like the homebuilding sector that benefit from customers taking advantage of those deductions would be limited, with luxury-oriented companies Toll Brothers (NYSE: TOL  ) and Ryland (NYSE: RYL  ) more at risk than homebuilders aimed at lower price points.

Implementing the Buffett Rule
The budget also wants to ensure that those with taxable income above the $1 million mark pay an effective tax rate of 30%. The mechanics of implementing what's become known as the Buffett Rule would include a phase-in of the tax for incomes between $1 million and $2 million, representing a further increase for those highest-income taxpayers with extensive deductions other than charitable contributions.

Lower inflation adjustments for tax-related provisions
The same proposal to link Social Security benefits to the chained Consumer Price Index would also have an impact on taxes. The budget would use the chained CPI to adjust tax brackets, personal exemptions, and standard deductions, leading to slower increases in those figures going forward. Unlike the limits on itemized deductions, the inflation adjustment provisions would affect all taxpayers.

Maximum amounts in IRAs and other retirement accounts
The budget would limit IRA, 401(k), and other tax-favored retirement balances to about $3 million. Combined with increases on carried-interest tax rates, this provision would capture hedge-fund managers and other investors who've used retirement accounts as successful high-growth investing vehicles.

A new cigarette tax
The Obama budget would hike federal taxes on cigarettes by $0.94 per pack. Altria (NYSE: MO  ) and other cigarette manufacturers would inevitably get hurt by such an increase, as it would add yet another impediment to cigarette demand that has already been falling sharply for decades.

Lower estate tax exemptions
The budget would reduce the current $5.25 million estate tax exemption to $3.5 million and push the top tax rate from 40% to 45%. That's still an improvement from what the estate tax would have looked like without the fiscal cliff compromise, with roughly $1 million exemptions and 55% top tax rates. But the failure to index the $3.5 million figure to inflation will create a need to revisit the issue repeatedly, which is a far cry from the certainty that inflation-indexing gave estate planners earlier this year.

Reduced tax preferences for energy production
Under current law, ExxonMobil (NYSE: XOM  ) , Chevron (NYSE: CVX  ) , and other energy producers are eligible for several tax benefits, including expensing for intangible drilling costs, percentage-based depletion for wells, and the domestic manufacturing tax deduction. The budget would remove these provisions.

Lower corporate taxes
The budget calls for broad reform of the corporate tax in an effort to cut its rate from 35% to 28% for most companies. Exactly how that reform would take place isn't entirely clear, but the general idea is to expand the base of money subject to tax to offset any rate reduction and keep the overall impact revenue-neutral.

Some limited tax breaks
The Obama budget also uses the tax laws to reward certain behavior. They include:

  • Making current educational tax credits permanent.
  • A 10% tax credit for small businesses to hire new employees or boost what they pay existing employees.
  • Tax credits to encourage employers to create retirement plans and automatically enroll their workers in those plans.
  • Special tax treatment for business investment and hiring targeted in certain high-poverty areas.
  • Tax incentives for education bonds used for building public schools.

Don't panic -- yet
Shares of tobacco companies like Altria, homebuilders like Toll Brothers and Ryland, energy giants Exxon and Chevron, and other businesses that would be hit by the budget proposal didn't drop dramatically yesterday. Moreover, the municipal bond market actually gained ground on a bad day for the bond market overall.

The lack of panic shows just how low a probability most people put on the Obama budget ever becoming reality. But as a sign of where the initial battle lines are drawn, knowing what the Obama budget means for your taxes can help you plan for likely compromise positions down the road.

Altria wouldn't like a cigarette tax, but it has dealt with them before and remains the best-performing stock of the past 50 years. Yet as the number of smokers in the U.S. continues to steadily decline, is Altria still a buy today? To find out whether everyone's love-to-hate dividend stock is a savvy investment choice or a hazard to your portfolio, simply click here now for access to The Motley Fool's new premium research report on the company.


Read/Post Comments (13) | Recommend This Article (6)

Comments from our Foolish Readers

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  • Report this Comment On April 11, 2013, at 10:53 AM, mdk0611 wrote:

    1. Making municipal bonds partially taxable is essentially shifting the burden to the states, most of whom are legally required to have balanced budgets. So not only would federal taxes go up, but state taxes would likely increase as well. Also striking in light of "tax incentives for education bonds used to build public schools.

    2. I wonder whether "public schools" include charter schools, or if this is a total sop to the teachers unions.

    3. Specific repeal of specified corporate deductions while there is a vague call for corporate tax reform including lower rates. What are the odds of seeing the lower rates after the deductions are repealed?

    4. An alternative to the alternative minimum tax? Why not call it the double secret final probation tax?

    5. Maximum balances for IRA's and 401(k)s? What if the taxpayer stops contributing and has a solid investment plan? Will there be required distributions? What if the taxpayer is under 59 1/2? Will there be a 10% penalty for successful investing?

    Let's just say I'm not impressed.

  • Report this Comment On April 11, 2013, at 12:24 PM, kaslackg wrote:

    Obama, really loves to Tax the poor doesn't he.

    He already taxed the poor twice, here we go again.

  • Report this Comment On April 11, 2013, at 12:51 PM, Victor0645 wrote:

    Now some of this budget sounds "OK"

    But obama has stated that he thinks the price of gas in the U.S. should be equal to the price in Europe. That means about $10. Now he want the oil companys to give up their tax breaks. That would make oil companies raise the price and obama would get his wish.

  • Report this Comment On April 11, 2013, at 1:39 PM, smith3459 wrote:

    So I assume that with the millionaires tax they will do away with the Alternative Minimum Tax, right? After al, that is only a tax on the rich (he says, dripping with sarcasm). If I believe that I probably am a fool.

  • Report this Comment On April 11, 2013, at 2:00 PM, mdk0611 wrote:

    The only way the price of gasoline in the US will be equal to Europe is if taxes on gasoline are a multiple of what they are today and a VAT is imposed. Oil companies would have very little to do with it.

  • Report this Comment On April 11, 2013, at 2:17 PM, Makikijoe wrote:

    I like the Buffet 30% rule and, if that rule were already in place a few years ago, Mitt Robbedme (um .... I mean, Romney) would have paid more than just a 13.9% tax rate that he paid one year.

    That fact, and the money that he once had in a Swiss bank account and in the Cayman Islands account was part of the reason he was rejected by the American voter.

    Not all millionaires are greedy creeps. For example, Bill Gates doesn't complain about paying too much tax.

    The rich should be VERY glad and should be VERY grateful that they have been blessed the way they have.

    And to the poster who said that Obama loves to tax the poor, I think it's hilarious to say that nonsense when his proposlas are mostly aimed at the people who CAN afford to pay an increase.

    I don't mind paying more in taxes if it's necessary to get the budget balanced and if it will help to pay down the national debt.

    We should not have been launching TWO expensive wars while simultaneously enacting TWO expensive tax cuts, as was done when Bush was president.

    Talk about being financially irresponsible !

    That left a legacy of debt which had to be dealt with by his successor. Note: The Bush tax cuts were passed with very few Democrats in support,

    Republicans don't mind being financially irresponsible, as long as what they do primarily benefits the wealthy.

  • Report this Comment On April 11, 2013, at 2:34 PM, sdchanman wrote:

    Destroy the middle class so you can say your not raising taxes on them....Lying liars and lying lies they tell.

  • Report this Comment On April 11, 2013, at 2:59 PM, 66wildflower wrote:

    I agree, removing tax credits to energy producing corporations will more than likely end up with increased cost at the pumps...passin it on down the line to consumers...to me that's obvious. BUT, in stating that " The budget would use the chained CPI to adjust tax brackets, personal exemptions, and standard deductions" is where it gets blurry...when they go messin around with the tax brackets is where it can hurt those of us in the middle of the road...any comments on this?

  • Report this Comment On April 11, 2013, at 3:49 PM, SoonShine wrote:

    What that Obama fool wants by implementing the chained CPI is basically this: If buying a can of dog food for dinner is the cheaper alternative to a box of macaroni and cheese, then buy the dog food, because the macaroni and cheese would be high end by comparison and people should not be overspending on brand name food labels or other necessities when the much cheaper alternatives are there. Obama's goal? He wants most of us to live like paupers so that we can pay more taxes!

    There should be a taxpayer revolt to make all elected officials in all levels of government live by the same rules they make!! No more perks, no more living high on the hog at taxpayer's expense!

  • Report this Comment On April 11, 2013, at 4:08 PM, Snoopy2012 wrote:

    When this country going to learn and vote out the liberal $hits out of office.

  • Report this Comment On April 11, 2013, at 4:10 PM, Snoopy2012 wrote:

    @Makikijoe - The problem with liberalism/socialism is eventually you are going run out of others money to spend.

    -Margret Thatcher.

  • Report this Comment On April 11, 2013, at 5:48 PM, NewAlchemist wrote:

    Cutting deductions, raising existing taxes, adding new taxes, limiting how much you can have in an IRA or 401(k)?

    To me that says if you work for a living and pay taxes you get to keep less and they get to keep more.

  • Report this Comment On April 12, 2013, at 2:35 PM, wolfman225 wrote:

    "A 10% tax credit for small businesses to hire new employees or boost what they pay existing employees."

    So let me get this straight. Part of Obama's plan to "help expand the middle class" is to have taxpayers begin subsidizing some business' payrolls? Not to mention that the proposed tax credit is unlikely to offset the costs of other Obama policies such as Obamacare and the recent proposals for big increases in the minimum wage. As well as expansion of other social safety net programs and unemployment benefit extensions.

    If Obama and the Democrats were truly interested in encouraging business and in creating an atmosphere of certainty conducive to economic growth and job creation, they'd drop the endless parade of so-called "targeted tax credits" and lower the tax RATES. They won't do that because power over the credits gives them power over industry.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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