President Obama’s 2016 Federal Budget Proposal

March 10, 2015

by By Tim Steffen

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On the heels of his first State of the Union address to the nation after the mid-term elections, President Obama released his fiscal year 2016 budget proposal.  This proposal contains many similarities to previous years, with a few new items that will affect retirement and estate planning strategies.  And like prior years, its revenue proposals – in their entirety – have very little chance of becoming law.  That’s especially true this year as Republicans now control both houses of Congress, and those Republicans immediately denounced virtually the entire package.  However, both parties seem focused on passing some type of tax reform this year, and in order to do that Republicans will likely have to concede on at least some of the president’s wishes.  Which of those may survive remains to be seen, but it’s now up to the Republicans in Congress to respond with a proposal of their own.

The president’s budget – By the numbers

Budget ProposalThe president’s budget signaled the end of sequestration, the program that created automatic budget cuts beginning in 2013, and instead includes an increase of more than 7% in total spending for the next fiscal year.

  • The 2015 budget forecasts tax revenue of almost $3.2 trillion, up more than $150 billion from 2014. Spending is budgeted at over $3.7 trillion, an increase of about $250 billion from 2014.
  • As a result, there is a projected deficit for 2015 of approximately $583 billion, a 20% increase over the 2014 deficit.
  • For 2016, the revenue and spending would be about $3.5 trillion and $4.0 trillion, respectively, leaving a deficit of $474 billion, more than an 11% decrease from the baseline deficit of $535 billion.  The baseline amount is the projected deficit before considering the president’s proposals.
  • Over the 10-year budget cycle of 2016-2025, the cumulative deficit is projected to be $5.674 trillion.  This is a reduction of more than $2 trillion from baseline number.  At no point during the 10-year cycle is the budget forecasted to balance.
  • Combined with other lending, the gross federal debt would rise from $17.8 trillion at the end of 2014 to $26.3 trillion at the end of 2025.

The following are some of the key tax and related provisions included in the president’s budget.

Significant changes to capital gain rules, including increased top rate

The president has used this budget proposal to suggest substantial changes to the tax treatment of capital gains – including those realized during lifetime as well as those gains transferred to others as gifts during life or bequests after death.

To begin with, the president is proposing to increase the top tax rate on long-term capital gains and qualified dividends to 24.2%, up from today’s top rate of 20%.  This rate would only apply to those taxpayers whose income is in the top tax bracket (for 2015, married couples with taxable income over $464,850 and singles over $413,200).  The 3.8% Medicare tax on investment income would continue to apply as under current law, bringing the combined top tax rate on capital gains and dividends to 28%.  This new rate would apply to gains realized and dividends received after 2015.

In addition, this budget proposes dramatic changes to the treatment of gifts and bequests.  Under today’s law, when appreciated assets are transferred to another individual, the original owner’s cost basis carries over to the recipient.  When those same assets are transferred upon the death of the owner, the cost basis is “stepped up” to the asset’s fair market value, thereby eliminating the gain.  Under this proposal, both gifts and bequests of appreciated property would be treated as a sale and repurchase of the property, causing the gain to recognized and be taxable to either the donor (for gifts) or recipient (for bequests).

There are a number of exceptions that would apply to this new gain recognition rule:

  • Gifts or bequests to a spouse would be exempt from this rule.  However, the original owner’s cost basis would carry over to the recipient, thereby simply deferring the gain on spousal transfers until the second death.  Transfers to charity would also be exempt from gain recognition.
  • The transfer of any personal property, such as household items or other possessions, would be exempt from this tax.  However, the transfer of appreciated collectibles would be subject to the tax.
  • A decedent could exclude the first $100,000 of gain realized upon the bequest of appreciated assets (no such exclusion would apply to gifts during lifetime).  This exclusion would be adjusted for inflation.  An additional exemption of $250,000 in gain on the transfer of a principal residence would also be available.  Any unused portion of either of these exemptions could be transferred to a surviving spouse, using rules similar to the estate tax portability rules already in place.
  • The proposal doesn’t address the treatment of assets that have fallen in value, but presumably the current step-down rules would continue to apply.
  • Capital losses and loss carry forwards would be fully deductible, even against ordinary income, on the final income tax return of the decedent.  Under current law, those losses can generally only offset capital gains realized in the year of death and can’t pass to a beneficiary, which means those losses often become worthless.  This provision would encourage the recognition of losses prior to an individual’s death so they could be used to offset other income.

These changes would all apply to gifts made or deaths occurring after 2015.  For more provisions related to the transfer of assets, see the section titled “Additional Changes to the Gift & Estate Tax”.

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