2012 not only marks the end of the Mayan calendar, but also the tax cuts of 2001 and 2003 under George W. Bush. With the aspect of likely higher taxes looming in 2013 some Congressional aides have termed the upcoming expiration of the Bush tax cuts as “Taxmageddon”. Are the expiration of the tax cuts in 2013 really going to be that painful for most people? If your income is below $200,000 to $250,000 probably not. Let’s take a look at some of the expiring provisions and the tax proposals that President Obama has included with his 2013 budget.
For the last couple of years ever since the “Bush” tax cuts of 2001 were extended through 2012, there has been much consternation as to what is going to happen to tax rates in 2013 when the extensions expire. A couple of weeks ago we got a peek at what President Obama’s proposed changes to taxes will be if he gets his way when he unveiled his 2013 budget. Of course, the budget and tax provisions will have to be approved by Congress, and there is a good chance that debate on tax law changes will drag out through much of 2012. It is very likely the proposals discussed below will be changed. We will likely not know for sure exactly what tax rates are going to be in 2013 and beyond until the end of 2012. However, we can look at the provisions that the President has included in his fiscal year 2013 budget and get an idea of the starting point of where tax rates may be in 2013 and beyond and if you need to worry much. Below is a look at some of the provisions that may affect the largest number of people:
Allow Top Two Income Tax Rates to Rise After 2012
The president is not really proposing an increase for the top income tax bracket in 2013, but simply allowing the current law to expire and reverting to the pre-2001 levels. This means that all taxpayers in the current 35% bracket would increase to 39.6%, this means you, if your taxable income is greater than $390,050, regardless if you are single, married or head of household.
The changes come in the 2nd highest brackets which are currently paying 33%, getting increased to 36%. But, this is only going to apply to joint taxpayers with Adjusted Gross Income (AGI) over $250,000 ($200,000 for single filers). The values are in 2009 dollars and would be indexed for inflation in future years. These taxpayers will be referred to as “upper income taxpayers”. The projected tax table is shown below along with current rates. For joint filers, with taxable income below the $250,000 threshold, but above the 28% tax bracket, their rates would stay at 33%, which would actually be a tax cut under the pre-2001 tax rates that the tax laws are reverting to.
For those taxpayers currently in the10%, 15%, 25% and 28% tax brackets there are not any proposed changes. Those people currently in the 33% bracket would only be affected if they are considered an upper income taxpayer.
Chart courtesy of taxpolicycenter.org
Tax Long Term Capital Gains at 20%
Ever since 2003 long term capital gains tax for assets held longer than 1 year has been 15% for those in the 15% bracket and higher, and 10% for those in the 10% bracket. (Since 2008 taxpayers in the 10% and 15% bracket actually paid no tax on long term capital gains). Under current tax laws, rates are set to revert in 2013 to their pre-2003 levels. This means for all taxpayers in the 15% bracket and below, long term gains would be taxed at 10%. For single taxpayers with taxable income below $200,000, head of households below $225,000 and joint couples below $250,000 your long term rate would remain at 15%. Only filers above these amounts would have a have a 20% long term capital gain rate.
Tax on Dividends
Another highly watched area of the proposed budget has been what the tax rate will be on qualified dividends. Before 2003, dividends were taxed at your ordinary income tax rate. Since 2003, though, the maximum qualified dividend tax rate has been 15%. (Since 2008, taxpayers in the 15% bracket or below pay no tax on qualified dividends.) When the current law expires in 2013, dividends would revert back to being taxed at your ordinary income tax rate.
President Obama’s budget proposal would keep the current dividend rate of 15% for everyone not considered an upper income taxpayer (single taxpayers with taxable income below $200,000, head of households below $225,000 and joint couples below $250,000). For the upper income taxpayers above these amounts, dividends would be taxed at your ordinary income tax rate of either 36% or 39.6%.
Limit Value of Itemized Deductions to the 28% Bracket
Itemized deductions allow one to reduce taxable income be deducting amounts greater than the standard deduction. This includes things such as charitable deductions, mortgage interest, state income taxes, medical expenses, etc. Itemized deductions are generally more valuable to upper income taxpayers because the effect on tax liability is greater when you are in a higher tax bracket. For example, itemized deductions of $10,000 reduce taxes for someone in the 15% bracket by 15% (15% of $10,000). But for someone in the 35% bracket, the $10,000 of deductions results in $3,500 of tax savings (35% of $10,000).
With the president’s 2013 budget proposal, the value of itemized deductions for those upper income taxpayers ($200,000 & $250,000), would be capped at 28%, so someone in the 35% that currently receives $3,500 of benefit for those $10,000 of itemized deductions, would only receive $2,800 of tax savings because of the 28% cap.
The possible effects of this likely have many charitable organizations concerned, as higher income donors are many charities biggest sources of revenues and if these people are not going to get as much “bang for their buck” with their charitable gifts, they may possibly give less in the future. You could also argue that investment in housing could be affected as well, since mortgage interest wouldn’t get the full benefit of the upper income taxpayer.
One other thing to consider, the limitation on itemized deductions (known as Pease after the congressman that helped create it) is scheduled to return in 2013. This limit reduces most itemized deductions by 3% of the amount by which AGI exceeds a specified threshold, up to a maximum deduction of 80% of itemized deductions. It was eliminated for 2010, 2011 & 2012, but unless the tax laws are changed will be back in 2013. It is likely it will affect only the upper income taxpayers ($200,000/$250,000) as well, but this combined with the 28% maximum itemized deduction limit could really reduce deductions for higher income taxpayers substantially.
Alternative Minimum Tax (AMT)
The Alternative Minimum Tax (AMT) was enacted in 1969 to impose tax on a small group of ultra- wealthy individuals that were paying little or no income tax because of excessive write-offs and deductions. AMT is a separate tax imposed on nearly a flat rate on an amount of income over a certain threshold (exemption). In computing taxable income, your regular federal tax is compared to the amount calculated under AMT and you are responsible for the greater of the two amounts. No deductions are allowed for things such as state income taxes or miscellaneous itemized deductions. The reason AMT has become such an issue the last few years and affecting more and more people at lower incomes, is because the exemption amount has never been indexed for inflation, so it is at a very low rate. The last several years, Congress has enacted a late December patch to inflation adjust the exemption. Due to the infinite wisdom of our elected officials, they have never added an automatic inflation increase to the AMT exemption, and we don’t know until late in the year if we will be paying several thousand dollars more in tax or not.
President Obama’s proposed budget has provisions that use the 2011 exemption amounts and permanently index the amount for inflation going forward, which would eliminate the last minute fixes by Congress.
Estate and Gift Taxes
In 2001, Congress voted to phase out the estate tax gradually and repeal it entirely in 2010. The 2010 tax act reinstated the tax with an effective $5 million exemption and a 35 percent tax rate. The act also for the first time allowed portability of the exemption between spouses: any of the $5 million exemption not used when one spouse dies may be added to the exemption available for the second spouse (if he or she has not remarried). However, unless Congress acts, the estate provisions in effect prior to 2001 would be reinstated starting in 2013, Under these provisions, estates valued at $1 million or more would again be subject to tax at progressive rates as high as 60 percent, and portability would disappear.
The Obama budget proposes permanently setting the estate tax at its 2009 level beginning in 2013: estates worth more than $3.5 million would pay 45 percent of taxable value over that threshold. It would also make portability permanent, allowing couples to share a combined exemption of $7 million. Relative to current law, the proposal would cost $271 billion in forgone revenues through 2021. (-From Tax policy Center website)
There are several more provisions for individuals and businesses in the proposed budget, but we wanted to focus on the areas that will likely have the impact on the largest amount of our clients and friends. Again, these are just the first proposals, there will be a lot of negotiations between the Republicans and Democrats before the final tax provisions are settled upon. From the looks of things right now, if your taxable income isn’t greater than $200,000 for individuals or $250,000 for joint filers, you probably would not see a lot of changes in your tax bill if the proposed changes make it to law.
Finally, Doug Short of Advisor Perspectives (always has great charts) has a neat chart showing the Federal Debt, including the effects of President Obama’s 2013 budget on top with the historical income tax brackets shown on the bottom half. When you step back and look at the long term, even with the proposed increases in income taxes for the upper income taxpayers, overall tax rates are a lot lower than they were in the middle of the 20th century. Of course, there were a lot more available tax deductions back then, so it may not really be all that different after all. But, I am just trying to cheer you up.