Tax Loopholes the President Left Out – for Now
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Tax Loopholes the President Left Out – for Now


President Obama gave policy experts plenty to chew on with proposed tax changes outlined in the run-up to his State of the Union address. His plan is to fund middle class tax breaks by closing loopholes that allow the wealthy to avoid taxes.

He pitched hiking the capital gains rate, eliminating the so-called “trust fund loophole” by requiring high earners to pay capital gains on inherited assets and adding a new tax on big banks with a lot of debt.

What happened to all the revenue raisers he didn’t mention? Here’s a look at some of the loopholes the administration has targeted in the recent past but that weren’t mentioned for 2015 – at least not yet.

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Carried Interest Loophole: Hedge fund and private equity managers get a special kind of income tax break for what’s known as “carried interest.” Basically, because they operate as partnerships, some of the profits they earn are taxed as capital gains, not income.

The carried interest loophole has garnered plenty of outrage in recent years because such wealthy people benefit from it. So why didn’t Obama target it?

One reason may be that it doesn’t really raise the kind of dough needed to fund the tax credits Obama wants to create. The administration has estimated that eliminating this tax break would raise about $1.4 billion over the next 10 years. In contrast, the proposals the president outlined would raise $320 billion in new tax revenue over that time frame.

Also, by raising the capital gains rate, taxing carried interest as income becomes less meaningful, points out Victor Fleischer, a tax law professor at the University of San Diego. Nonetheless, he predicts that taxing carried interest as income will be part of the budget Obama sends to Congress in February.

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Corporate Loopholes: President Obama has emphasized business tax reform in recent years, but aside from the new tax on big banks, he didn’t have many specific proposals this week.

That doesn’t mean more aren’t coming. In his speech, Obama said, “Let’s close loopholes so we stop rewarding companies that keep profits abroad, and reward those that invest in America.” That means new rules requiring companies to repatriate profits are likely coming.

Other provisions Obama has trumpeted before, such as limiting corporations’ ability to deduct interest on debt or taxing large, publicly traded partnerships as corporations, will likely be back, says Martin Sullivan, chief economist at research firm Tax Analysts.

“The president is saving a lot of revenue raisers for tax reform,” Sullivan says, rather than simply pairing them with tax cuts for the middle class proposed at the State of the Union.

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He expects serious business tax reform to move to the front burner later this year. “Obama has had a long list of revenue raisers in the past,” says Sullivan. The State of the Union is not the time for him to “mention all of them or even come close to mentioning all of them.”

Mortgage Interest Deduction: One of the largest tax subsidies enjoyed mainly by the wealthy is the hallowed mortgage interest deduction. It is available to anyone with a mortgage, but the benefits go mainly to the wealthy, who tend to have more expensive homes and more interest to deduct.

There have been plenty of proposals to phase it out, cap it, or turn it into a tax credit. Eliminating the deduction for second homes seems especially likely to resurface in an administration proposal. But with the housing market still wobbly, this would be an inauspicious time for Obama to include a proposal that would so obviously reduce the benefits of homeownership.

Family Trusts: By proposing to eliminate what tax experts call the “step-up in basis” and Obama calls the “trust fund loophole,” wealthy families stand to lose a significant way to avoid estate and gift tax. But he’s not eliminating trust funds.

In fact, he’s actually increasing the tax benefit of setting up a trust fund, points out Forbes staff writer Janet Novak. “The loophole Obama is aiming at has nothing to do with trusts and closing it could actually increase the tax appeal of trusts,” she wrote in a recent column.

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Semantics make it hard for Obama to tackle the “trust fund loophole” and actual trust funds at the same time. This is a clear and obvious target for his stated goal of making sure the very wealthy pay their fair share of taxes.

The Buffett Rule: Floated by Obama in 2011 and defeated by the Senate in 2012, the Buffett Rule would have imposed a minimum 30 percent tax rate on people who earn a million a year. It got its name because Warren Buffett observed that he was paying a lower effective tax rate than his secretary.

Obama likely didn’t mention it because it is dead politically. This is the kind of difficult tax reform that may be tackled at a later date and possibly could be lumped in with changes to the related and much-maligned alternative minimum tax (AMT), which still hits many middle-income taxpayers.

Another reason Buffett is on the back burner: Obama’s proposed hike in the capital gains rate would reduce the gap between effective tax rates of the wealthy and the middle class without a separate rule.

The State of the Union is just the start of a renewed discussion of tax reform, say experts. While Republicans dismiss the president’s current proposals as political non-starters, it isn’t the last we’ve heard from them. And there are many more proposals that are likely to resurface as the 2015 budget process really gets in gear.

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