This column was written by William R. Bischoff, a certified public accountant in Colorado Springs, Colorado for PPC, which is part of the tax and accounting business at Thomson Reuters. The opinions expressed here are his own.
The so-called Bush tax cuts (from legislation enacted in 2001 and 2003) are scheduled to expire at the end of this year. But you may not understand the full extent of what is in store if Congress simply sits back and allows the expirations to occur without making any changes.
Here are some highlights:
Higher income tax rates
Some of you may believe that only individuals in the top two federal income tax brackets will face higher rates when the Bush cuts go bye-bye. Not true! Unless Congress takes action and President Obama goes along, rates will automatically go up for everyone who pays taxes — not just “the rich.”
Specifically, the existing 10% bracket will go away, and the lowest “new” bracket will be 15%. The existing 25% bracket will be replaced by the “new” 28% bracket; the existing 28% bracket will be replaced by the “new” 31% bracket; the existing 33% bracket will be replaced by the “new” 36 % bracket; and the existing 35% bracket will be replaced by the “new” 39.6% bracket.
My take: The Administration has pledged to keep the three lowest brackets (the 10%, 15%, and 25% brackets) in place. The 28% bracket would be expanded to accommodate unmarried taxpayers with income (whatever that is determined to mean) below $200,000 and joint filers with income below $250,000. Only taxpayers with income above those levels would be affected by the new 36% and 39.6% rates. However, Congress must make changes, and the president must go along for these things to happen.
Right now, that’s looking more problematic than a few months ago, and it now appears that Congress won’t even bring up the subject until sometime after returning from its summer recess in August. The only thing we know for sure is that tax rates will go up for everyone if Congress sits on its hands.
The marriage penalty will get worse
The Bush tax cuts put a relatively favorable framework for married individuals in place to reduce the so-called marriage penalty, which can cause a married couple to pay more federal income tax than if they were single. Note that the marriage penalty still exists for many married couples, but it’s not as harsh as before the Bush tax cuts. However, unless Congress makes changes and the president goes along, the marriage penalty will automatically get worse when the Bush tax cuts expire.
Currently, the standard deduction for some married couples is as much as 200% of the amount for singles. Starting next year, the new lowest bracket of 15% for married filing joint (MFJ) couples will be only 167% as wide as the 15% bracket for singles and the new standard deduction for married couples in other brackets – as well as those who file taxes separately — isn’t as generous.
My take: Presumably, the Administration’s pledge to keep things the same for lower and middle-income taxpayers includes extending the Bush tax cut elements that reduce the impact of the marriage penalty. However, extending those elements would require Congress to make changes and the president to go along. Will it happen? We don’t know, and neither does anyone else.
Higher capital gains and dividends taxes for all
Right now, the maximum federal rate on garden-variety long-term capital gains and qualified dividends is 15 percent. Starting next year, the maximum long-term capital gains rate will increase to 20 % (or 18 % on gains from assets held for over five years). Dividends will once again be taxed at ordinary income rates. So, the maximum rate on dividends will balloon to a whopping 39.6 %.
My take: The Administration has repeatedly said the current 0% and 15% rates on long-term capital gains and qualified dividends will be left in place except for married couples with income above $250,000 and unmarried individuals with income above $200,000.
For that to happen, however, Congress must take action and the president must go along. A few months ago that looked likely, but now it looks more problematic. In particular, we think the odds are rising that dividends will once again be taxed at ordinary rates (of up to 39.6 %), starting next year. We hope we are wrong.
In addition to these changes, both the itemized deduction and personal exemption phase-out rules will return with a vengeance. But current versions of the child tax credit, earned income credit, dependent care credit, and adoption credit are also likely to be continued.
Stay tuned for developments, but don’t hold your breath. Our Washington politicians don’t seem to be in a big hurry to resolve the many tax uncertainties that we have summarized here. Even worse, it appears the odds are increasing that we may not see resolution until after the November election. Good grief!