Most of us have heard it all before. The federal government spends too much and bad things happen. Many of us remember when the federal government did shut down (twice) during the Clinton administration. Then we went on to a great economic expansion. Now we are hearing it all again, so it must be just politics again. Right? Everything will settle back to normal. Everything will be fine. Right?

Or is it different this time? Have we reached a point where the rhetoric is actually warning us of a real problem? We are making our way out of a very serious recession and credit crisis. At this time, many believe that the U.S. economy is strengthening and the stock markets are rising. Corporations are making money again. Could all the arguments over the national debt and the Obama budget really mean something to us as CPAs?

How the Federal Budget Affects CPAs

Whether you are a CPA in public practice or a CPA working in industry, as a trusted business advisor to your employer, your clients and potentially both, you have to be concerned about any governmental change that affects business on a number of levels. Budgets can be especially important to a CPA because of the changes in the tax code brought on by the budget process. We will see a number of important tax issues proposed in the 2012 federal budget intended to raise revenue or stimulate the economy.

Picture $3,700,000,000,000

On February 14, 2011, President Obama introduced his budget for the fiscal year ending September 30, 2012. How the $3,700,000,000,000 spending proposal is finally allocated and how Congress revises the finances of the federal government in the process can make a great deal of difference to your business. Let’s stop here and develop a clear idea about how to quantify $1 trillion. For example, if you spent $1 every second, you would have spent $1 million in 12 days. To spend $3.7 trillion, you would have to spend $1 per second for over 117,300 years. Clearly, even small changes to an almost $4 trillion federal budget can have an enormous impact.

Tax Code Revisions and the Obama Federal Budget for 2012

As with any budget, there are projected expenses and there are expected revenues. In the case of the government, tax collection drives those revenues. So, as part of the $2.6 trillion revenue package incorporated in to this budget, President Obama is proposing some of the following changes to the existing tax code:

Kill LIFO

Of primary interest to CPAs are proposals to eliminate LIFO as an acceptable method for valuing inventory. Of course, this allows for a lower carrying cost of inventory since the last unit in (theoretically the most expensive in any type of inflationary economy) with be the first unit out. Over time this will increase cost of goods sold and decrease taxable income. According to CPA firm McGladrey, “2012 budget proposal provides for a 10-year LIFO reserve recapture period. A repeal of LIFO would eliminate a tax deferral opportunity for taxpayers that may have inventories with costs that have increased over time.”

Permanent Index the Alternative Minimum Tax to Inflation
 
The Obama 2012 budget seeks to index the alternative minimum tax (AMT) parameters to inflation after 2011. Members of Congress have proposed the revision or repeal of the AMT for some time, but the AMT is a substantial revenue generator for the government and it is unlikely to be abolished in the future. Therefore, creating a permanent solution through indexing is logical.

Extend ‘Bush Era’ Tax Cuts — But Only for Certain Individuals

McGladrey also pointed out that the tax-rate reductions (a.k.a. Bush tax cuts) enacted in 2001 and 2003 were scheduled to sunset in 2011 and revert back to pre-2001 rates. The 2010 Tax Act extended the tax rate reductions, but only through 2012. The Obama budget includes revenue assumptions based on “permanently extending the reduced tax rates, but only for taxpayers with adjusted gross income (AGI) of $200,000 or less for single filers or $250,000 or less for married filers.”

Reduce Capital Gains Tax on Low Income Individuals

Currently, capital gains rates are fixed at zero percent and 15 percent. “For years beginning on or after Jan.1, 2013, the Administration has proposed to increase the capital gains tax rate to 20 percent, but only for upper-income taxpayers. The Administration has also proposed a 20 percent tax rate on qualified dividends that would otherwise be taxed at a 36 percent or 39.6 percent tax rate.”

Extend Section 179 Expensing

After 2012, the president proposes to permanently extend the Section 179 expensing limit of qualified equipment purchasing to $125,000 with an annual investment limit of $500,000. There is also a proposal to index the amount to inflation.

Eliminate Capital Gains on Qualified Small Business Stock

McGladrey has also pointed out that President Obama would revise how ownership of small businesses (non-corporations with less than $50 million in gross assets) could sell and exclude the gain on a sale of small business stock. The AMT preference treatment would also be eliminated.
 
Permanent Extension of the 2009 Estate and Gift Tax Provisions

President Obama expects that the current terms requiring an exemption amount of $1 million and a tax rate of 55 percent will be extended and made permanent.

Permanently Extend the Research Tax Credit

The credit is computed based on a complex formula that is a function of the increase of current year qualified wages, supplies and outside contractors over historical levels or R &D expenses in relation to gross receipts. The credit is temporary and must be extended by legislation every year or two. After being extended retroactively in late 2010, the credit is again scheduled to expire on Dec. 31, 2011. As proposed, the research tax credit will be made permanent, effective January 1, 2012. The credit would also be enhanced by increasing the alternative simplified credit rate from 14 percent to 17 percent.

Calculate the Foreign Tax Credit Based on Pooling

Generally, foreign tax credit limitations conceptually limit the U.S. tax credit to the lesser of the actual foreign tax or the pre-credit U.S. tax on the foreign income. To maximize foreign tax credit utilization, companies commonly seek opportunities to blend the effective foreign tax rate from multiple foreign sources, seeking to mix high-and low-tax foreign income. After December 31, 2011, the new proposal would require taxpayers to consolidate the earnings and taxes of all of their foreign subsidiaries into an annual pool and compute deemed paid foreign tax credits using the consolidated earnings and profits repatriated from foreign subsidiaries.

Continue Some Expiring Provisions Through Calendar Year 2012

• Several energy incentives including:

• Grants for specified energy property in lieu of tax credits;

• Credits for alcohol fuels, bio-diesel, renewable diesel, alternative fuel and alternative fuel mixtures;

• Credit for alternative fuel vehicle refueling property;

• Credit for non-business energy property.

• Individual tax relief, including:

• Deduction for state and local general sales tax;

• Deduction for qualified tuition and related expenses;

• Tax-free distributions from individual retirement accounts (IRAs) to certain public charities for individuals aged 70 1/2 or older, limited to $100,000 per taxpayer per year.

• Business tax relief, including:

• Fifteen-year straight line cost recovery for qualified leasehold, restaurant and retail improvements;

• Various enhanced charitable contribution deductions;

• Expensing of brownfield environmental remediation costs;

• Subpart F exception for active financing income;

• Look-through treatment of payments between related controlled foreign corporations (CFCs) under foreign personal holding company rules;

• Work opportunity tax credit.

Make Unemployment Insurance Surtax Permanent

Federal Unemployment Tax Act (FUTA) currently imposes a 6.2 percent payroll tax on employers for the first $7,000 paid to each employee annually to pay for unemployment insurance benefits. The 6.2 percent rate also includes a temporary surtax of 0.2 percent that was passed by Congress in 1976. The surtax has been extended several times, most recently through June 30, 2011. As proposed under this budget, the proposal would make the 0.2 percent surtax permanent.

Tax Relief to Employers/Expand Federal Unemployment Tax Act (FUTA) Base

The proposal would provide short-term relief to employers by suspending interest payments on state unemployment insurance debt and suspending the FUTA credit reduction for employers in borrowing states in 2011 and 2012. It would also raise the FUTA wage base to $15,000 per worker paid annually in 2014, index the wage base to wage growth for subsequent years and reduce the net Federal unemployment insurance tax from 0.8 percent (after the proposed permanent extension of the FUTA surtax) to 0.38 percent.
 
End Tax Deductions for Punitive Damage Payments

The current practice of allowing a deduction for punitive damages incurred as part of a legal settlement would cease and if the liability for punitive damages is covered by insurance, the damages paid or incurred by the insurer would be included in the gross income of the insured. The insurer would be required to report such payments to the insured and to the IRS.

 Repeal Lower-of-Cost-or-Market Inventory Accounting Method

The current proposal would prohibit taxpayers from writing down the value of FIFO inventories. These changes would be effective for taxable years beginning after Dec. 31, 2012 and any one-time increase in gross income would be included ratably over a four-year period beginning with the year of change. The provision would raise revenue of approximately $8.2 billion over 10 years.

Impose a Penalty on Failure to Comply With Electronic Filing Requirements

This proposal would establish a penalty for a failure to comply with a requirement to file a return electronically. The amount of the penalty would be $25,000 for a corporation or $5,000 for a tax-exempt organization. The proposal would be effective for returns required to be electronically filed after Dec. 31, 2011.

Permanent Portability of Unused Estate Tax Exemption Between Spouses

This proposal would extend portability permanently, making the use of the last predeceased spouse’s unused exemption available to all estates of decedents dying and gifts made after Dec. 31, 2012.

Spending Changes and the Obama Federal Budget for 2012

The federal budget submitted by President Obama for the fiscal year ending September 30, 2012 contains a number of significant spending changes as compared to the same agency for the fiscal year ending in 2010. There are many provisions that, while not directly affecting business, can have a long-term impact on business. The complete budget document can be referenced and agency-by-agency summaries can be useful in doing individual research on any specific items not mentioned here.

According to the proposed budget submitted to Congress by the White House, the following agencies will see funding changes (vs. the 2010 budget). View the federal agency, the total funding and the variance the 2010 fiscal year listings in the 2012 Federal Budget by Agency sidebar at the end of this article.

Is There an Action Plan Based on the Obama 2012 Budget?

As CPAs and trusted advisors, you are expected to guide your clients and their businesses through these very difficult times. Forearmed with a clear idea that 2012 may not be just another budget year, be prepared to advise your clients based on what may be a new set of realities.

Ron Box, CPA.CITP, CFF, CISSP, is the chief financial officer and chief information officer for Joe Money Machinery, a Birmingham, AL.-based regional heavy construction distributor with operations in Georgia and Florida. Box also serves as chair for the 2010 AICPA Top Technology Task Force and is a member of the AICPA Certified Information Technology Professional (CITP) Credential Committee.