I plan on taking an ambling walk through the President's various tax proposals that are part of his 2014 budget. The best view of the proposals is at this pdf. In this part 1, I'll be focusing on some of the sexier proposals that have or will get press. A lot of these, I think, can be filed under "good idea, but it won't raise much revenue as taxpayer behavior shifts to avoid the tax hikes."
Without further ado, let's go:
The budget proposes that carried interest, by which the profits interest received for services rendered to an investment partnership are treated like any other partnership interest such that the character of the income passes through to the service-performing partner, be treated as ordinary income. For a myriad of reasons, this is a good idea (as I've noted in several diaries). The central conceit of the carried interest regime - which resulted from a string of court cases a few decades ago - is that the value of the profits interest is so speculative that it can't be valued, and accordingly is valued at zero at the time of receipt. In other words, it's a valuation issue first and foremast. Under broadly accepted theories of valuation, the value of any income-producing asset is the net present value of future cash flows, which means that we do have a good, reliable way of valuing the carried interest: each dollar of profit tacks on more value, so prospectively we can just treat the actual receipt of profit ex post as part of the value received ex ante. In other words, there's no reason we have to deem the receipt of the interest itself as the taxable event; we could as easily break the asset into its cash flow components and treat those as the compensatory event. And that's what this proposal does: each dollar of profit received is compensation, and we're basically "revaluing" the initial receipt of the interest as more income comes in. Will it bring in much revenue? Probably not. The effective tax rate on hedge fund carry won't change much (and may go down in some instances!), and, because private equity funds work with c-corps that have flexible capital structures, those capital structures can be switchified around in order to garner capital gains treatment. For instance, target corp creates a new share of stock that represents residual cash flows over and above current cash flows such that it's valued at near zero. The fund would purchase those shares for close to nothing, and if target thrives those shares would rocket up in value and could be sold like any other capital property. Not much revenue would be generated, I'd wager, but it's still a good idea by getting rid of the valuation problem that lies at the heart of the tax treatment of the carry.
Capping the value of IRAs
The exclusion for contributions to qualified retirement plans (IRAs, 401ks, 403bs, pensions, etal) would be eliminated once the cumulative balance exceeds a certain amount, which is $3,400,000 for an IRA. I think this is a fine idea, even if $3MM is low enough to capture a lot of accounts (midlevel execs that have contribute the max to their 401ks and have a pension, for example, can often push $3MM in IRA assets). If a retiree's only asset is a $3,000,000 IRA, and they spend $100K in retirement, that IRA will be gone by the time they're in their 90s. I could see people squawking about that, and reasonably so, but at the same time.....meh. This one could pose some serious administrative headaches, since it requires taxpayers and employers to do some complex actuarial calculations for their pensions in order to figure out whether further contributions are deductible or excludable. And, since the discount rate would likely be set by the IRS each year, it could mean that pension contributions may be excludable in one year and taxable the next. What does that mean for the taxation of the payments in retirement? It means a giant fucking headache, that's what it means.
As far as incremental revenue.....tough to see it getting too much. Once people hit $3MM, they're probably close to retirement and may not be contributing too much. It would also mean that compensation may just be shifted into nonqualified retirement plans, which gets the same tax treatment but isn't subject to the limitations.
Ending lifetime distributions for inherited IRAs
Under current law, an IRA left to a child can be distributed out over the child's expected lifespan. The proposed change would require that an inherited IRA be distributed over a 5 year period, rather than "stretched" over their lifetimes. Spouses could still stretch out the distributions over their lives, but children would have to take them in a 5 year period once they hit the age of majority (21 in most places). On a personal note, this would make my life easier: the worst part of any estate review is searching the trust provisions for language that would screw up the IRA distribution stretch; the rules on this are maddeningly complex. Since distributions to a trust that doesn't have special features have to be distributed over 5 years, this provision would equalize the treatment of distributions to trusts and natural persons. And, since many people with large IRAs don't want a 21 year old to get an enormous IRA distribution, it also means that more people will be looking to set up trusts to protect their kids from getting huge windfalls at a young age. This provision should raise a decent chunk of change.