Raising the capital gains and dividend tax rates and eliminating certain inheritance tax provisions for high earners are among the tax code changes President Obama proposed in his State of the Union speech Tuesday night.

At the same time, President Obama called for the adoption of a number of benefits targeted to lower- and middle-income taxpayers including new tax credits, enhanced paid sick and maternity leave, and financial support for community college tuition. The president’s proposals, which will become part of the administration’s draft budget, are not formal legislation, but instead represent the administration’s priorities and recommendations to Congress. Considering that Republicans control the Senate and the House, these proposals are not likely to advance in the short term or at all.
Still, taxpayers will want to monitor any potential changes to the tax code. Among the president’s proposals:

  • Eliminate the “stepped-up” basis provision for inherited assets for high-income individuals. Most appreciable assets currently receive a new cost basis upon the death of the owner equivalent to the value at the date of death. The proposal would eliminate the stepped-up basis provision and treat inherited assets and gifts as so-called “realization events,” and therefore, taxable. Charitable organizations would be exempt from this rule.
  • Raise the top capital gains and dividend tax rate to 28% from its current 20% for higher-income individuals. The top rate applies to couples with income higher than about $500,000. It was unclear if the rate was inclusive or exclusive of the 3.8% Medicare surtax on investment income.
  • Consolidate tax incentives for college savings, and scale back 529 college savings plans. The president’s plan would consolidate savings tax incentives from a variety of college savings plans into one vehicle, redirecting those savings advantages into the American Opportunity Tax Credit. The proposal also calls for the rollback of expanded tax cuts for 529 savings plans that were enacted in 2001 for new contributions. Earnings on new contributions to 529 savings plans would become taxable when withdrawn. Also, tax incentives for the smaller Coverdell Education Savings program would be repealed.
  • Limit the maximum amount that can be held in an individual retirement account to about $3.4 million.

As the budget process moves forward, it will be important to monitor potential tax law changes. Still, comprehensive changes to the tax code are not likely until 2017. Though there is broad consensus that the tax code needs to be simplified, opinions vary widely on which provisions to eliminate or change, and whether the goal of tax reform should be to increase net revenues.


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