President Obama asked Congress, in the budget he submitted on February 1, to extend a 50% “depreciation bonus” for another year through December 2010.

This improves the odds that the benefit will be extended, perhaps as part of a “jobs” bill sometime between February and May. Any extension would be retroactive to January 1.

The President’s budget is not automatically adopted in the United States, even when his own party controls Congress, unlike in countries with parliamentary systems.

The depreciation bonus would reward companies investing in new equipment in 2010 by letting them deduct 50% of the cost immediately for tax purposes. The other 50% is depreciated normally.

The benefit is worth between 2.61¢ and 8.98¢ per dollar of capital cost in tax savings, with the higher savings on transmission lines, conventional power plants and other assets that would otherwise be depreciated over long periods. Such long-lived assets could be completed as late as 2011 under the Obama proposal and still qualify for a bonus, but the bonus would only be calculated on spending through December 2010.

Other energy facilities — like wind farms, solar and geothermal projects that are normally written off over five years — would have to be completed by December 2010 to qualify. The bonus on such projects would be only 42.5% in practice — not 50% — because only 85% of the cost of such projects can be depreciated if the owner also will receive a Treasury cash grant for 30% of the project cost. Most owners of such projects built in 2010 are expected to receive such grants.

Obama also asked Congress to allow another $5 billion in tax credits to be claimed by companies that build new factories to make wind turbines, solar panels and other products for the green economy. The tax credits are 30% of the factory cost. Anyone wanting to claim such credits must apply to the Internal Revenue Service for an allocation. The economic stimulus bill in February 2009 authorized $2.3 billion in such tax credits. Applications to the IRS for the credits were more than three times this amount. The IRS would allocate the new credits over the next two years.

This proposal has considerable support in Congress, although solar manufacturers have been urging Congress to move the credit to a different section of the US tax code that would let them claim it without having to apply for an allocation and without any cap.

The President proposed again that Congress tax hedge fund and private equity fund managers on the value of carried interests they receive in exchange for their services at ordinary income rates. The interests are interests in future profits. The managers are able to pay taxes on what is essentially compensation at reduced tax rates for long-term capital gain by selling the interests after holding them for at least a year. The proposal is not likely to pass Congress.

Obama also took aim at tax deferral by US multinational corporations on their earnings from offshore subsidiaries, but backed down from tougher proposals — that were not enacted — in the budget last year.

Under US tax rules, all borrowed money is considered fungible. If a US parent company borrows in the United States, a portion of the interest is considered a cost of its foreign operations in the same ratio that its assets are deployed in the US and abroad. This has the effect of making it harder for the US company to credit taxes it pays to other countries against its US income taxes. It can only claim credit for such taxes to the extent of the taxes the US would have collected on the company’s foreign earnings. To the extent that its domestic borrowing in the United States is considered a cost partly of its business operations in India, for example, that means the company is considered to have earned less in India and this reduces its ability to credit taxes paid in India against its taxes in the United States.

Nevertheless, the full interest paid by the US parent is deductible when computing its US income taxes.

Obama asked Congress to allow any interest treated as a cost of foreign operations to be deducted only when the foreign earnings are repatriated and taxed in the United States. This would not prevent US companies from deferring US taxes on foreign earnings by keeping the earnings offshore, but it would reduce the benefit from deferral and complicate tax calculations.

The budget also attacks a growing trend by US companies to move intellectual property into offshore holding companies in places like Ireland and Luxembourg as a way of keeping a share of earnings outside the US tax net. It would treat the “excessive” after-tax returns earned by such holding companies as “subpart F income,” meaning that the United States would look through such holding companies and tax the US shareholders on the excess returns directly.

Congress is not expected to tackle foreign tax reform this year, although with US budget deficits now running to 11% of US gross domestic product, some form of tax increases are considered inevitable in the long run.

Obama would reinstate a top US tax rate of 39.6% on ordinary income and 20% on capital gains for higher-income individuals by letting Bush-era tax cuts that reduced the top individual rate to 35% and the capital gains rate to 15% expire at the end of this year.

The budget would also scale back a series of tax benefits for production of oil, gas and coal, following through on a promise the President made at the G-20 summit last year in Pittsburgh. However, such proposals lack broad support in Congress. 

Keith Martin