Tag Archive | "budget"

President Once Again Takes Aim at Reinsurers

By: Gregory Arroyo

For the sixth time, President Barack Obama is taking aim at reinsurers, including in his fiscal-year 2016 budget language that would end some of the tax benefits they enjoy. Market insiders, however, believe the administration’s latest attempt to tax foreign reinsurers will once again receive little support from members of Congress.

In his budget presented on Monday, Feb. 2, the president proposed to make reinsurers pay a 14% one-off tax on cash held offshore and a 19% tax on future earnings. If passed, the proposal would make the cost of reinsurance, especially catastrophic coverage, more expensive.

According to insurance ratings company A.M. Best Co., the proposal is fielding strong opposition from member of Congress representing states that have considerable exposure to natural catastrophes. “Their concern is that a tax increase could lead to increased costs for (re)insurance coverage, or possibly a decrease in allocated (re)insurance capacity for less profitable risks,” the firm stated, in part. “Accordingly, any resolution of this issue could be years away.”

According to an economic study by the Tax Foundation’s Center of Federal Tax Policy, the president’s measure and similar legislation proposed by Reps. Richard Neal (D-Mass.) and Bill Pascrell (D-N.J.) and Sen. Robert Menendez (D-N.J) would cost the economy more than four dollars for every dollar raised. The study also projected that over the long term, the United States’ GDP would experience $1.35 billion in losses, which is approximately twice the revenue it would collect.

“The proposal is well thought out and serious, but ultimately mistaken on the policy merits,” the report states, in part. “While the deduction eliminated is neatly matched with income exclusion, there are substantial drawbacks to the proposal.”

In recent years, Democrats and Republicans have fought over ways to tax the huge stockpiles of cash held abroad by U.S. companies. Democrats want these companies to pay the current U.S. corporate tax rate of 35% on overseas profits, which Republicans have fought. However, Senator Rand Paul has signaled his support for a 6.5% tax.

“If anything were passed, it would probably be the 6.5% tax, which would still make the non-controlled foreign corps. a favorable alternative, especially for producers way above the small casualty insurance company threshold premium of $1.2 million per year,” noted Jim Smith, chairman of SouthwestRe. “I think the consensus is that with a Republican Congress and Democratic President, not much of anything is going to happen, and this proposed tax increase has even less chance than other bills.”

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Tax Changes Ahead?

The recently released White House budget for fiscal year 2013 proposes numerous tax changes for individuals, businesses, and investors. In general, the budget seeks to leave tax rates the same for individuals with incomes of $200,000 or less ($250,000 or less for married couples). However, taxpayers with incomes above these thresholds would face higher taxes as the administration seeks to reduce the deficit and fund other priorities. It is important to keep in mind that the president’s budget is only an outline of his policies and priorities. While some of the policies may be adopted, most are unlikely to pass both chambers of Congress—especially in an election year.

Here are the key proposals affecting individuals and investors:

1. Extend some—not all—2001 and 2003 tax cuts.

Numerous tax cuts were enacted in 2001 and 2003, including a reduction in income tax rates, 0 percent and 15 percent tax rates on long-term capital gains and qualified dividends, lower estate taxes, marriage penalty relief, and expansion of the child tax credit. These tax cuts are all scheduled to expire after December 31, 2012.

The president’s budget proposes to extend these tax cuts only for taxpayers with incomes at or below $200,000 (single filers) and $250,000 (married filing jointly). For those with incomes above these thresholds, the tax cuts would expire beginning January 1, 2013. This means:

  • The 33 percent and 35 percent income tax rates would increase to 36.0 percent and 39.6 percent, respectively
  • The 15 percent tax rate on long-term capital gains would increase to 20 percent
  • The 15 percent tax rate on qualified dividends would be eliminated, and qualified dividends would be taxed as ordinary income, at a top rate of 39.6 percent (a significant change from the president’s previous budget proposals which would have capped the tax rate on qualified dividends at 20 percent)
  • Personal exemptions and itemized deductions would phase out at higher income levels

These changes would be in addition to the new 3.8 percent Medicare contribution tax that is set to take effect on January 1, 2013 (more on this below).

Outlook: Extending the 2001 and 2003 tax cuts for upper-income taxpayers will be a key debate in the elections this year. As a result, I don’t think a compromise will be reached before November. Instead, I believe Congress will return after the elections in a lame duck session to negotiate a compromise. The outcome of the tax extension debate will depend on which party has more influence after the elections.

2. Reduce the value of itemized deductions and other tax benefits.

Under current law, taxpayers can deduct many items from their income, such as home mortgage interest and charitable contributions. For example, an individual with $100 of income in the 35 percent tax bracket, who claims $10 of itemized deductions, would reduce his or her income tax by $3.50. Several items are also excluded from federal income tax altogether, such as interest on municipal bonds and contributions to 401(k) accounts (if certain conditions are met).

The president’s budget would cap the value of all itemized deductions and some exclusions at 28 percent. As a result, taxpayers in the 33 percent and 35 percent tax brackets would see the value of these tax benefits reduced. In the example above, the individual claiming $10 of itemized deductions would have his or her income tax reduced by $2.80 instead of $3.50. This cap would apply to home mortgage interest, charitable contributions, tax-exempt interest on municipal bonds, the amount an employer pays for health insurance, and contributions to 401(k) accounts, traditional IRAs, and health savings accounts, among other items.

Outlook: Many members of Congress on both sides of the political aisle have raised concerns over this proposal. Nonetheless, it has emerged in various debates as a way to pay for other legislation. I believe enactment is unlikely, but can’t be ruled out.

3. Impose higher taxes on millionaires.

The president’s budget outlines several principles for tax reform. One principle is that those making more than $1 million annually should pay no less than 30 percent of their income in taxes. In addition, the budget indicates that tax subsidies for millionaires should be eliminated, with the exception of a limited tax incentive for charitable giving. This so-called “Buffett Rule” would replace the existing alternative minimum tax (AMT).

Under current law, long-term capital gains and qualified dividends are taxed at a top rate of 15 percent. By contrast, wages and salaries are taxed at a rate of anywhere from 10 percent to 35 percent. As a result, someone like Warren Buffett, who receives most of his income from investments, rather than wages, could pay the same tax rate as a middle-income individual.

Outlook: A version of the Buffett Rule has been introduced in the Senate. However, I do not expect it to be enacted into law this year.

4. Increased estate and gift taxes.

The president’s budget proposes to return to the higher 2009 estate and gift taxes. The maximum estate tax rate would increase from 35 percent to 45 percent, and the per-person amount exempt from the estate tax would drop from $5.0 million to $3.5 million.

Outlook: The decision about changing estate taxes will likely be debated in the context of extending the 2001 and 2003 tax cuts. As a result, I do not believe the estate tax will be addressed before the elections in November.

One definite 2013 change.

The new 3.8 percent Medicare contribution tax on net investment income, enacted under the healthcare reform law, is set to take effect on January 1, 2013. This tax is imposed on the lesser of a taxpayer’s (1) net investment income or (2) modified adjusted gross income that exceeds $200,000 (for single filers) and $250,000 (for joint filers). Net investment income includes interest, dividends, annuities, royalties, and the taxable portion of capital gains from the sale of a home, among other items.

Expect debate ahead.

I believe there will be a robust debate over taxes, tax reform, and deficit reduction in 2012. However, the political environment of an election year isn’t conducive to Congress compromising on major issues. I expect the extension of the 2001 and 2003 tax cuts to be the biggest tax debate of the year, but it will likely not be resolved before the November elections. Rather, I expect to see a repeat of 2010—where final agreement was reached in a post-election, lame duck session of Congress. Depending on the political dynamics after the election, final resolution could even be kicked into 2013 when the new Congress is seated. This tax debate will unfold as the U.S. government again approaches the debt ceiling (Treasury estimated that last summer’s debt limit law will extend the government’s borrowing authority through the end of this year). As a result, expect lots of headlines and uncertainty as we head into November.

This article was written by Shahira Knight and posted on Fidelity.com.

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