How Obama's Tax Plan Could Affect You

published 1 November 2008

Even before President-elect Barack Obama is sworn in as the 44th president of the United States in January, his transition team and congressional leaders will be working on ways to stimulate the economy and provide taxpayers with some relief to cope with the most challenging economy in more than 80 years.

With Democrats controlling both houses of Congress, lawmakers are likely to approve a new round of economic-stimulus checks during an expected lame-duck session, says Clint Stretch, director of tax policy for Deloitte Tax. But more-comprehensive changes , such as boosting income-tax and capital-gains rates on the wealthiest Americans, may have to wait until the economy strengthens, Stretch predicts. Growing federal budget deficits will make it difficult to fulfill many expensive campaign promises. And Congress will have significant influence over whatever proposals are ultimately enacted into law.

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Temporarily eliminating the annual required minimum distributions from IRAs for Americans 70 and older was one of the few proposals on which Obama and Republican presidential candidate John McCain agreed. Both said it was unfair to force seniors to sell investments in the current bear market in order to fulfill their annual distribution requirements by December 31. Although suspending mandatory withdrawals would allow some investors to avoid selling stocks hammered by the market, it would help only those people who could afford to skip their annual required minimum distribution. Seniors who need the money will have to tap their IRAs regardless of whether they are required to do so. Obama has suggested that withdrawals up to the amount that would normally be required under minimum-distribution rules should be tax-free.

Obama also proposed that workers, many of whom are grappling with job losses and home foreclosures, be allowed to tap up to $10,000 of savings in their 401(k) or similar workplace-based retirement plan penalty-free in 2008 and 2009. Withdrawals would still be subject to the usual federal and state income taxes. Under current law, workers can borrow up to half of the balance in their 401(k) or similar workplace-based retirement plan up to $50,000. In some cases, they can qualify for a hardship withdrawal, subject to taxes and early-distribution penalties. You can't borrow from an IRA, but you can take early withdrawals that will be taxed and penalized. Roth IRA contributions (but not earnings) can be withdrawn any time tax-free and penalty-free.

Broader changes to the tax code may have to wait until the Obama administration sorts through its priorities on how to deal with the economy, health care, energy independence and education. In general, Obama's tax proposals would benefit mainly low- and middle-income Americans and would increase taxes on high-income taxpayers, defined as families with income of more than $250,000 ($200,000 for individuals), according to an analysis by the nonpartisan Tax Policy Center, in Washington, D.C.

Obama says his plan—which would extend the current low income-tax and capital-gains-tax rates for the majority of Americans and add new tax breaks for low-income workers, students, seniors and homeowners—would result in a tax cut for 95% of Americans. He has indicated he would reinstate the top two income-tax rates of 36% and 39.5% and increase the maximum capital-gains rate from 15% to 20%. Those changes would apply to households with income of $250,000 or more ($200,000 for individuals). But the current rates on income and capital gains, as well as estate taxes, do not expire until 2010, so there is little pressure for immediate action.

During the heat of the campaign, when gasoline prices topped $4 a gallon, Obama also proposed a windfall-profits tax on oil companies and said he would use the revenue to give filers an immediate $1,000 rebate to help cope with higher fuel costs. But with gasoline prices now at less than $3 a gallon and oil trading at about $70 a barrel, it is unclear whether a windfall-profits tax would still be appealing. However, the fact that ExxonMobil reported a record $14.8-billion profit in the third quarter -- up 58% from a year earlier -- may keep the windfall-profits tax on the front burner as Congress desperately searches for revenue with which to fund middle-class tax cuts.

Obama also pledged to protect middle-income Americans from the alternative minimum tax, a parallel tax system enacted in 1969 to ensure that the rich pay at least some tax. Because the AMT was never indexed to inflation, it now threatens to saddle tens of millions of middle-income Americans with higher taxes. As part of the $700-billion economic-rescue plan earlier this year, Congress approved another one-year patch, boosting the AMT exemption amount to keep more than 21 million additional middle-class taxpayers from paying the tax in 2008. Proposals to eliminate the AMT are politically popular but prohibitively expensive. A more likely scenario is that Congress will continue approving AMT patches, adjusted for inflation.

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