President's 2010 Budget Proposal

EXECUTIVE SUMMARY

On February 26, 2009, President Obama unveiled his $3.55 trillion budget blueprint for the fiscal year 2010. While the full budget details will be made available in April 2009, this proposal offers a glimpse at the Administration’s priorities over the next 10 years. The outline describes dozens of programs that should be of interest to businesses and individuals alike. The centerpiece of the President’s ambitious agenda—an extension of a two-year tax credit under the “Making Work Pay” program and significant changes in healthcare policy—will be funded, in large part, by two revenue-raising proposals: a cap-and-trade program whereby companies must buy permits to exceed pollution emission caps, coupled with an increase on the top two individual income tax rates and stricter limits on the amount of itemized deductions taken by individuals who fall within those tax brackets. There has been the great debate in recent days over the size and scope of the President’s 2010 Budget and the proposed means of paying for these new Administration priorities. Below is a sampling of some of the programs, listed by department, agency or subject matter, that have an effect on the business operations of our clients, either financially or through enforcement mechanisms:

TAXES

Business Benefits. The business community has been very vocal about the increased taxes and penalties proposed by the President. In response to these concerns, the Administration has focused its message to the public on the few areas of tax relief found within the Budget, which include: making permanent the Research and Development Tax Credit effective as of 2010, expanding the Net Operating Loss carryback effective as of 2009, and eliminating the capital gains taxation on small businesses.

However, in order to fund many of his new governmental programs, President Obama's Budget also contains significant tax increases on certain segments of the individual and business population. These tax increases will be extremely controversial, particularly given the current economic climate, and therefore, the President has delayed many of the enactment dates until 2011, when President Bush’s tax cuts are set to expire.

Impact on Businesses. Of importance to many businesses, the President’s Budget would end the long-accepted tax-accounting technique called “last-in, first out,” or LIFO, that benefits many businesses, including those in the oil and gas industry, retailers, automakers and makers of non-automotive heavy equipment, textile makers, consumer products manufacturers, drug companies, as well as alcohol and tobacco manufacturers and wholesalers. The accounting method has been commonly used since the 1930s and has been widely viewed as the most accurate measure of income for financial statement purposes, according to the nonpartisan congressional Joint Committee on Taxation. In addition to this change in accounting methodology, the Budget increases taxes on businesses by: taxing carried interest paid to managers of hedge funds and private equity funds as ordinary income rather than as investment gain, reinstituting Superfund Taxes, and increasing a variety of taxes on oil and gas companies.

Impact on Small Businesses and Individuals. The Budget proposes a number of serious tax increases on certain small businesses and/or individuals. Of importance to many small businesses and individuals, the Budget reinstates the top-two tax rates of 36% and 39.6% for individuals earning over $250,000 (married) and $200,000 (single). This increase is significant not only because of its impact on individuals, but because a majority of small businesses pay taxes at the top-two individual rates. In addition, the Budget would return the dividend tax rate to 20%. The Budget also resurrects the estate tax, which was set to be repealed next year, at its 2009 rates that includes a maximum exemption of $3.5 million and a top rate of 45%. The Budget reinstates the Personal Exemption Phaseout and limitation on itemized deductions for those earning more than $250,000 (married) and $200,000 (single), and it also limits the mortgage-interest deduction for those in the top-two tax brackets. Capital gains rates are also increased from 15% to 20% for upper income individual taxpayers.

HEALTH CARE

Creation of Reserve Fund. The Budget lays the groundwork for comprehensive reform of the American health care system, most notably by setting aside a reserve fund of over $630 billion over the next 10 years to help finance health care reform. This is perhaps the President’s most ambitious plan, and it will be heavily debated in the coming months. One-third of this reserve fund would come from the revenue generated by increasing taxes on individuals in the top-two income tax brackets, as noted above. Nearly one-third of the reserve fund comes from cuts to the Medicare Advantage program by requiring competitive bidding. While no specifics are provided in this area, it appears that this will require plans to bid against each other based on their underlying costs, but would not permit costs to exceed Medicare Advantage benchmarks under current law. The remaining portion of the reserve fund is financed from a collection of revenue-generating proposals that are aimed at cutting federal payments to hospitals, insurance companies and drug companies, therefore placing an increased financial burden on those affected industries. Some of these proposals include: requiring drug manufacturers to raise discounts on Medicare drugs from 15 percent to 21 percent; increasing premiums on higher-income Medicare beneficiaries who seek to participate in the prescription drug coverage; cutting Medicare payments to health insurance companies that provide comprehensive care to more than 10 million of the 44 million Medicare beneficiaries; and, cutting Medicare payments to hospitals that re-admit a large proportion of patients within 30 days after they are discharged, by bundling payments to cover not just the hospital’s own services, but also the cost of any care provided by nursing homes and home health agencies in the month after patients left the hospital. Many of these provisions will have severe impacts on insurance companies, hospitals, drug companies, and associated businesses, and it is certain that these industries will work hard to fight these changes over the coming months.

ENERGY

Cap-and-Trade. One of the White House’s biggest, and most controversial proposals involves development of a cap-and-trade program to reduce greenhouse gas emissions by roughly 14 percent below 2005 levels by 2020, and by approximately 83 percent below 2005 levels by 2050. The President’s plan includes the auctioning off of all of the emission credits that companies would need to purchase to participate in the carbon market, instead of giving some of those credits away for free. This new policy would impose a $79 billion annual cost to the economy, or $646 billion over 10 years. The revenue from this auction would begin to be distributed starting in 2012, with $120 billion going to "clean energy" technologies by 2019 and nearly $526 billion going to the President’s "Making Work Pay" tax credit by 2019. This provision has created great concern among many affected businesses and the Republicans in Congress. It is expected that this program will be at the center of congressional debate on the Budget.

EDUCATION

The President’s 2010 Budget provides $46.7 billion for the Department of Education, which is intended to expand early childhood education programs, strengthen and reform public schools to meet the needs of all students, and work with states to develop rigorous standards and assessments to improve student achievement. In addition, the Budget will play a key component in the President’s goal of doubling funding for the Early Head Start program and expanding the Head Start program. The Budget increases the maximum Pell Grant award to $5,500 in the 2010-2011 school year, ties future increases in Pell awards to the Consumer Price Index plus 1-percent, and makes spending on Pell Grants mandatory instead of discretionary, which requires Congress to fully fund the program and its yearly increases. The Budget also creates a new five-year, $2.5 billion Access and Completion Incentive Fund to support innovative state efforts to help low-income students complete college.

HUD

The Budget fully funds the Community Development Block Grant program with a goal of ensuring that communities continue to invest in and expand economic opportunities for low-income families. It also creates a new Choice Neighborhoods Initiative, which would challenge public, private and nonprofit partners to identify neighborhood interventions that would have a significant return on Federal investments. The Budget lays the groundwork for creation of an Energy Innovation Fund, which supports creation of an energy-efficient housing market, including the process of retro-fitting certain aging homes. The Budget also provides the initial funding for the Affordable Housing Trust Fund created last summer, as well as strengthens efforts to combat mortgage fraud and predatory lending.

JUSTICE

While most of the funds allocated to the Department of Justice go to traditional law enforcement priorities, it is important to note that a portion of the resources allocated to the FBI are intended for the hiring additional FBI agents to investigate mortgage fraud and white-collar crime and for additional federal prosecutors, civil litigators and bankruptcy attorneys to protect investors, the market, the federal government’s investment of resources (including in this Budget proposal, as well as the various stimulus plans), and the American public.

COMMERCE

The Budget launches a $50 million initiative that will create a nationwide network of public-private business incubators to encourage entrepreneurial activity in economically distressed areas. The Budget provides over $1.3 billion to develop and acquire vital weather satellites and climate sensors for weather forecasting and climate data records.

TRANSPORTATION

The Budget proposes a $1 billion per year high-speed rail State grant program, which seeks to link several regional population centers across the country.

AGRICULTURE

The Budget provides $1.3 billion in loans and grants to increase broadband capacity and improve telecommunication service.

The Budget also anticipates an increase in savings by eliminating direct payments to farmers making more than $500,000 in annual sales. The Budget also includes many other reductions in payments to farmers, which the Administration is relying on for increased savings to be used to fund many of its new programs over the next decade.

LABOR

The Budget increases funding for: the Occupational Safety and Health Administration, for the purpose of vigorously enforcing workplace safety laws and whistleblower protections; the Wage and Hour Division, in an effort to ensure that workers are paid the appropriate wages; and the Office of Federal Contract Compliance Programs, which is charged with ensuring equal employment opportunity and a fair and diverse Federal contract workforce.

CONCLUSION

The President’s 2010 Budget Proposal is certain to please some groups, while angering others. The final budget submission will come in April, 2009, and only then will we know more specific details on many of the President’s new programs. There has already been some indication that many of the tax increases could see changes before the final budget submission. Stay tuned, as we will keep you informed of any such changes when they are presented in April.

No representation is made that the quality of legal services to be performed is greater than the quality of legal services performed by other lawyers.

Disclaimer regarding legal advice - The information in this newsletter should not be construed as legal advice. This information is not intended to create or constitute an attorney-client relationship. For more information or an explanation about the matters discussed in this newsletter, please contact an attorney in this practice group.

IRS Circular 230 Disclosure - To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.