Jul 11, 2012 14:28
Guest post by Lori Figlioli, CPA – Senior Tax Manager, Alpern Rosenthal
The year 2012 began with the fate of the "Bush-era" tax cuts uncertain, and no resolution appears in sight. The Congressional Budget Office has estimated that extending all of the "Bush-era" tax cuts would cost $2.84 trillion over 10 years. Democrats and Republicans remain far apart on whether to extend all or some of the "Bush-era" tax cuts and other tax incentives scheduled to sunset after 2012. Reaching an agreement between the Democrats and Republicans before the November elections is not likely. The likelihood of a lame-duck Congress deciding the fate of the "Bush-era" tax cuts is increasing daily. Also growing daily is the uncertainty many taxpayers face in tax planning for 2013 and beyond.
The "Bush-era" tax cuts are provisions enacted into law primarily by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). EGTRRA made over 30 major changes to the Tax Code which are about to sunset. However, the impact of the expiration of the "Bush-era" tax cuts on individuals has received the most attention because its effect is so great.
Individual Income Tax Rates
According to the Congressional Budget Office, extending the reduced individual tax rates would account for over half of the total revenue loss, the costliest provisions to extend by far. If the "Bush-era" tax cuts expire as scheduled, the individual income tax rates will increase across-the-board and all taxpayers will see an increase in tax. Unless extended, the individual tax rates, currently at 10, 15, 25, 28, 33, and 35 percent, are scheduled to revert to 15, 28, 31, 36, and 39.6 percent, effective for tax years beginning after December 31, 2012. All taxpayers will effectively experience an increase in tax after 2012 by not realizing the advantage of having the first dollars of income subject to the 10% bracket.
Individuals should consider shifting the timing of income and deductible expenses due to the possibility of being subject to greater tax after 2012. Accelerating income into 2012 might lower the overall tax liability as well as deferring deductions into 2013 to offset income that would be subject to a higher rate of tax.
Tax Rates on Capital Gains and Dividends
The 2010 Tax Relief Act extended the reduced maximum tax rates of 15% on qualified capital gains and dividends, originally enacted by JGTRRA. Absent extension, the maximum tax rate on net capital gains will revert to 20% after 2012. Thus, one strategy for taxpayers to consider is accelerating capital gains into 2012 while the tax rates are 15%.
Qualified dividends will be taxed at the applicable ordinary income tax rates after 2012, absent extension. With the highest individual tax rate scheduled to be 39.6% this could create a large increase in tax for some individuals.
Before EGTRRA, some married couples experienced the so-called marriage penalty. The penalty can force a married couple to pay more taxes than when they were single. EGTRRA gradually increased the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return. Starting in 2013, the deduction for married couples will fall back to about 167% of the deduction for single individuals, rather than 200%, if marriage penalty relief is not extended.
EGTRRA also increased the upper limit of the 15% bracket for joint filers to equal 200% of the upper limit for single filers. After 2012 the upper limit of the 15% bracket for joint filers is scheduled to be equal to 167% of the upper limit for single filers. As a result, married couples may want to increase their withholding or make larger estimated tax payments starting in 2013 to avoid any adverse impact from the sunset of the increased 15% rate bracket and standard deduction for married couples.
Limits on Itemized Deductions
Before EGTRRA, a phase-out rule ("Pease" limitation) could eliminate up to 80% of a higher-income individual's itemized deductions for mortgage interest, state and local taxes, and charitable donations. The rule was gradually eased and finally eliminated. However, it is scheduled to be revived after 2012.
Personal Exemption Phase-Out
Another nasty phase-out rule prior to EGTRRA could eliminate some or all of a higher-income individual's personal exemption deductions. Under the phase-out, the total amount of exemptions that may be claimed by a taxpayer is reduced by 2% for each $2,500 by which the taxpayer's adjusted gross income exceeds the applicable threshold. This phase-out was repealed through 2012 and absent extension will be revived after 2012.
A number of credits will also be affected if the current tax laws are not extended. The Earned income, Child Tax, Adoption, and Child and Dependent Care credits were all enhanced by the "Bush-era" tax cuts that are set to expire at the end of 2012.
There are also a number of education-related tax incentives scheduled to expire, or be significantly reduced, after 2012.
Alternative Minimum Tax
EGTRRA and subsequent laws enacted so-called AMT "patches." The patches increased exemption amounts for the growing number of taxpayers subject to AMT. The patches also allowed refundable personal credits to the full amount of the individual's regular tax and AMT liability. The most recent patch, in the 2010 Tax Relief Act, expired after 2011.
The House GOP has proposed to eliminate the AMT. However, proposals to abolish the AMT have stalled in Congress, largely due to the projected loss of revenue. They are expected, however, to patch the AMT for 2012 and possibly 2013 until a more permanent solution is found. The Joint Committee on Taxation has estimated that a one-year AMT patch for 2012 would reduce revenues by $92 billion over the 2012-2021 budgetary window.
The "Bush-era" tax cuts gradually reduced the estate tax leading to its repeal in 2010. The 2010 Tax Relief Act reinstated the estate tax with a 35% top tax rate and a $5 million applicable exclusion amount, and a step-up in basis through 2012. The 2010 Tax Relief Act also introduced the new "portability" feature allowing a deceased spouse's unused exemption to be shifted to the surviving spouse. Because the 2010 Tax Relief Act sunsets after 2012 absent extension, the maximum federal estate tax rate is scheduled to revert to 55% with an applicable exclusion amount of $1 million, not indexed for inflation, and the portability of the estate tax exemption will no longer be available.
The "Bush-era" tax cuts don't just offer tax relief to the wealthiest Americans. They offer it to just about anyone who pays federal income taxes. Their scheduled demise at the end of the year will raise the tax bill of nearly every taxpayer. Congress may choose to balance the objectives of deficit reduction and economic assistance by extending certain provisions it determines are effective, while letting others expire.
This column was originally published in Alpern Rosenthal's Tax eNewsletter. Alpern Rosenthal, a Top 100 accounting firm, provides a full range of accounting, auditing, tax, business advisory and consulting services to a diversified client base of privately-held and public companies, as well as a large number of not-for-profit organizations.