The President's Plan to Change Your Taxes, Explained

January 20th 2015

Mike Vainisi

President Obama wants to make some changes to our tax system, and he'll be discussing it tonight.

First, give me the gist of what he wants to do.

Sure. Here's what we know so far: They amount to a series of tax breaks for middle class families, working families, the poor, and students. The president will ask Congress to pay for those tax cuts with tax increases on the wealthy and the financial sector. Put together, this would raise $320 billion in new revenue while providing $175 billion in tax relief and benefits for the middle class and poor.

These proposals, by the way, are considered "dead on arrival" in the Republican-controlled Congress, meaning that they have no chance of being passed into law in this form. Republicans are not fans of soaking the rich in order to pay for tax cuts.

These are important proposals, however, because they set the tone for the next two years of debate between the president and Congress. And they also set the tone for the 2016 presidential campaign.

So what are the tax cuts?

+ Tax credits for families with small children (about $3,000 per child).

+ More money for the working poor through the Earned Income Tax Credit (EITC).

+ An extra $500 to married couples who are both working.

+ Make permanent the American Opportunity Tax Credit, which refunds families up to $10,000 in college expenses over four years. It is set to expire in 2017. This costs the government about $15 billion a year.

+ Exclude Pell grants and forgiven student loans from taxation.

That sounds expensive. How does the president propose we make up for the lost revenue resulting from those tax breaks? Doesn't he also want to make community college free?

Here is how the president thinks we should pay for the tax breaks and free community college:

+ An increase in the capital gains tax rate to 28 percent for couples making more than $500,000 a year. It's currently at 23.8%. The capital gains tax kicks in when you sell a non-inventory asset (such as stocks or bonds) for more than it cost to buy. So, if you bought a stock for $2 and sold it for $4, you'd be taxed on that $2 gain. The Obama administration is making that case that this is merely a return to the capital gains tax rate while Ronald Reagan was president. Republicans argue that, nevertheless, it's a big tax increase.

+ Closing a trust fund tax loophole. It's often used by wealthy Americans to transfer large sums of money through inheritance without taxation.

+ A new tax on banks with more than $50 billion in assets.

+ Another change to capital gains -- elimination of the stepped-up basis. (Trigger Warning for anyone who had a bad experience in a tax class in college.) The stepped-up basis allows people who inherit an asset to avoid paying the same capital gains tax if they had bought it. So, if your parent buys a stock for $2 and then it goes up to $5, that's a $3 gain. If your parent sold the stock at $5, she'd be taxed for the $3 gain. If she doesn't sell, however, and then dies, leaving you the stock in her will, you will only be taxed on gains above $5. That is, your new gain is based on what the stock was when you got it ($5), not what it was when your parent purchased it ($2). The Congressional Budget Office says this loophole cost the government $50 billion in 2013 and that 21 percent of the benefits were collected by the top 1 percent.

+ Cap contributions to tax-preference retirement savings accounts (such as IRAs) at $3.4 million. This was an issue in the 2012 campaign when it was revealed that Republican presidential nominee Mitt Romney had $21.3 million in one of these accounts.

+ Here's a controversial one: Tax special college savings accounts, called 529 plans. These accounts are pretty simple: You put money into them and it grows, tax-free, until your kids go to college. Then, you can use it to pay tuition. The president wants to tax those accounts.