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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:

Carried interest.
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.

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Comment Preferences

  •  How does the "capping of IRAs" work? (1+ / 0-)
    Recommended by:
    johnny wurster

    Is it solely on the contribution side? And is it cumulative for all of a taxpayer's IRAs? Would it require an employer to seek information from each employee regarding balances in other qualified plans before making contributions to their own plans on behalf of an employee? Or are the burdens entirely on individual taxpayers? And how are excess contributions handled? Taxable to employees with/without premature distribution penalties?

    This sounds like a nightmare from a purely practical standpoint.

    •  Yes, yes, probably? (2+ / 0-)
      Recommended by:
      Kane in CA, VClib

      Sounds like it's just on the contribution side (ie, I don't see anything requiring distributions of excess balance), and it's cumulative across all qualified plan.  So if you have a $1.5MM IRA and a pension plan where the NPV of future distributions is $1.7MM, then any contributions by the taxpayer or employer are included in the W-2 or, if made by the taxpayer, non-deductible.

      Since there are two variables floating around - investment return rate and discount rate for the NPV - it sounds like a giant mess.  

      Good point about who will bear the burden; if I'm an employer, do I really want to ask my employees for their total IRA and 401k balances so I can calculate the exclusion amount?   No fucking way.  

      Here's the language from the budget doc:

      the Administration proposes to limit the deduction or exclusion for contributions to defined contribution plans, defined benefit plans, or IRAs for an individual who has total balances or accrued benefits under those plans that are sufficient to provide an annuity equal to the maximum allowable defined benefit plan benefit.  this maximum, currently an annual benefit of $205,000 payable in the form of a joint and survivor benefit commencing at age 62, is indexed for inflation, and the maximum accumulation that would apply for an individual at age 62 is approximately $3.4 million.  the proposal would be effective for taxable years beginning after december 31, 2013.
      •  Query whether this will kill pensions. (2+ / 0-)
        Recommended by:
        VClib, Kane in CA

        There are still some out there, especially for professional partnerships.  It may not be worth it anymore to set them up.  With an IRA, it's fairly easy to see what the balance is, but with a pension it can get complicated fast.

        •  The unintended consequences are always (2+ / 0-)
          Recommended by:
          johnny wurster, nextstep

          interesting. When ERISA was passed in 1974 the intent was to shore up defined benefit pension plans. Corporations read the law and started ending their defined benefit plans and converting retirement programs to 401Ks. ERISA had the unintended consequence of killing pension plans in the US.

          Thanks for the diary.

          "let's talk about that"

          by VClib on Fri Apr 12, 2013 at 07:44:35 AM PDT

          [ Parent ]

      •  Ok, but then what? (2+ / 0-)
        Recommended by:
        VClib, johnny wurster

        So if it's not the employer's responsibility, then the contribution is made anyway, and if the employee has other qualified plans that make it an excessive contribution, then it is the employees responsibility to report that income on their 1040. (Not sure how well that will work out) But then what happens to the contribution? It's already in the employer plan. It stays in there and is taxed again upon distribution? Or the employee requests a distribution from the plan trustee? Subject to SS and medicare taxes?

        And more thinking and typing...It would seem these valuations would have be be based on the beginning of the year balances, so as to limit contributions for the year. Many plans don't use calendar years, so don't issue calendar year end valuations (for other than voluntary deferral accounts). And same thing for DB plans, in addition to the already complicated new burden of determining a PV, they'll have to do it at something other than the plan YE.  

        This is one of those things that may be a good idea (though I'm not convinced the limits are appropriate), but there is just no practical way to implement.

  •  IRAs? (0+ / 0-)

    Well,  for those fortunate few who actually have one with more than 5 figures in it,  I'm sure this is relevant.

    don't always believe what you think

    by claude on Fri Apr 12, 2013 at 07:25:23 AM PDT

  •  Mostly over my head but I trust you. (1+ / 0-)
    Recommended by:
    johnny wurster

    I do have one question, though.

    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.
    Am I correct, as someone who will be in this situation on a much smaller scale, to note that the IRA wouldn't actually be gone that quickly because the balance of the $3M continues to do its interest-bearing thing even as $100K/yr is distributed?

    You know, I sometimes think if I could see, I'd be kicking a lot of ass. -Stevie Wonder at the Glastonbury Festival, 2010

    by Rich in PA on Fri Apr 12, 2013 at 08:56:56 AM PDT

    •  that assumed, IIRC, 5% rate of return (2+ / 0-)
      Recommended by:
      Rich in PA, VClib

      over the whole lifespan and 3% inflation on the spending.

      •  so it's an inflation-adjusted $100k (1+ / 0-)
        Recommended by:
        johnny wurster

        I was crudely multiplying 100k x 30 years (retire at 65, die at 95) without adjusting the nominal value of the spending. Which is why I'm neither a latex salesman nor a financial consultant.

        You know, I sometimes think if I could see, I'd be kicking a lot of ass. -Stevie Wonder at the Glastonbury Festival, 2010

        by Rich in PA on Fri Apr 12, 2013 at 09:33:10 AM PDT

        [ Parent ]

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