Wall Street Partners Targeted for Obamacare Tax in Budget Plan

  • Provision is among $2.6 trillion in new revenue measures
  • Proposal aims to apply 3.8% tax for Medicare to more taxpayers

Some high-earning partners in hedge funds, private-equity firms and other businesses organized as so-called pass-throughs would pay a 3.8 percent health-care income tax under President Barack Obama’s 2017 budget request.

The proposal would extend a “net investment income tax” for Medicare that’s been in place since 2013 to taxpayers who have successfully characterized their income in ways the tax doesn’t reach, according to Obama administration officials. Combined with another provision, which is designed to require more business owners to pay self-employment taxes, the change is projected to raise $271.7 billion over the next decade.

The measures are part of a package of revenue proposals that collectively would raise $2.6 trillion from 2017 through 2026, according to the president’s budget request, which was released Tuesday. The revenue it seeks is 67 percent higher than Obama’s 2016 proposal, driven by international tax-reform proposals, changes in the way high-income individuals are taxed and a previously announced fee on oil of $10.25 per barrel.

The spending plan is expected to face opposition in Congress, where budget committees in the House and Senate have signaled their disregard. They don’t plan to ask Obama’s chief budget architect to make his customary appearance to defend the proposals.

Closing Gap

The 2010 Affordable Care Act, known as Obamacare, sought to shore up funding for Medicare by creating a 3.8 percent tax on net investment income for people who make more than $200,000 a year. Now, the administration proposes to close what budget documents call a “a gap” in legal definitions that determine who has to pay that levy.

In essence, Obama’s budget would extend the 3.8 percent investment tax’s provisions to income that individuals receive for performing services -- such as managing investments -- at partnerships, LLCs and S corporations. The administration would reach those taxpayers by applying the investment tax to “gross income and gain from any trades or businesses of an individual that is not otherwise subject to employment taxes.”

Partnership Technique

At the same time, the budget proposes to make individual owners of “professional service businesses” subject to self-employment taxes in the same way, regardless of how their business is structured. Under current law, certain structures allow for avoiding self-employment levies.

The measures would counter an aggressive technique that lets investment-fund managers typically avoid most of the self-employment tax by using a complex structure, according to David Miller, a tax lawyer focused on financial transactions at Cadwalader, Wickersham & Taft LLP.

Miller described a technique in which an entity that manages an investment fund is set up as a limited partnership, in which the general partner overseeing the fund owns a tiny stake, typically 0.1 percent. Generally, limited partners, who aren’t currently subject to the self-employment tax, hold the remaining 99.9 percent interest -- allowing the individual owners of the fund manager to skirt the tax.

The proposals reflect that a growing portion of America’s business income is generated through structures other than the traditional C corporations -- the familiar form of a publicly traded company, like General Electric Co., which pays corporate income tax.

Targeting Pass-Throughs

So-called pass-throughs, which range from mom-and-pop businesses to giant funds, aren’t subject to income taxes and pass profit down to investors, who are taxed. Pass-through entities such as partnerships and S-corporations now generate more than half of U.S. business income,  according to a 2015 paper by the National Bureau for Economic Research. Since 1980, pass-throughs have accounted for more than half the growth in the income share of the nation’s top 1 percent of taxpayers, according to that paper.

The proposals represent “a direct shot at pass-throughs,” said Brian Reardon, president of the S Corporation Association of America, a trade group. The proposed increases would push the top overall tax rate on S corporation owners well above 40 percent, he said. C corporations pay a top statutory rate of 35 percent.

“We’re not too happy about it,” Reardon said.

Pressing Inversions

The budget also repeated Obama’s call for international tax reform -- while more than doubling the revenue his policy prescriptions are expected to raise from it to $484 billion over 10 years. One reason for the increase: “a larger number of companies that are taking advantage of what we think are loopholes that need to be closed,” said White House budget director Shaun Donovan at a briefing.

The centerpiece of that reform package, which was introduced last year, would impose a 19 percent tax on corporations’ foreign earnings -- regardless of whether they bring that money back to the U.S. Under current law, corporations can keep such earnings offshore indefinitely while deferring income taxes on them. In this year’s budget, that tax alone is projected to raise $350.4 billion over 10 years.

Donovan said the Obama administration is taking steps to curb corporate inversions, the practice of moving a U.S. company’s tax address offshore by merging with a foreign company, via executive orders and will keep pressing Congress to act as well.

The budget includes other provisions that Obama has proposed before. A fee of seven basis points, or 0.07 percentage points, on the liabilities of large U.S. financial firms -- roughly the 100 biggest firms, with assets of more than $50 billion -- would raise $111 billion over 10 years. Obama reiterated his call for the Buffett Rule, named for billionaire investor Warren Buffett, which would impose a minimum tax rate of 30 percent, beginning with income levels over $1 million.

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