Monday, June 25, 2012
Lower tax rates are set expire at the end of 2012
Most observers agree that Congress is going to have a hard time addressing
tax and budget issues before the November elections, says Shahira Knight,
Fidelity’s vice president of government relations. "More likely, action will
wait until a lame-duck session of Congress, or 2013, and that’s unsettling for
investors and the markets,” she notes. “It may be a roller-coaster ride as key
So where does that leave you as a taxpayer and investor? “A good approach is to be prepared for a range of possibilities, and to start now,” says Jim Buza, vice president of guidance and advice for Fidelity. “That’s really what you should do in any climate, but it’s especially critical now.” To get started, use our tax calculator to the right to estimate how you might be impacted.
The tax cuts enacted by Congress in 2001 and 2003—often referred to as the Bush tax cuts—provided a broad range of tax relief, including lower tax rates on income, long-term capital gains, and qualified dividends. We dodged the expiration of these lower taxes back in 2010 when Congress extended the tax cuts for two years (through 2012). Now cuts are set to expire on December 31, 2012, and any action will likely come down to the wire as it did in 2010.
It’s difficult to predict what will happen, but three scenarios are possible:
The tax rates on long-term capital gains and qualified dividends, which are currently 15% (0% for taxpayers in the lowest two income brackets) are also set to change. Without Congressional action, the long-term capital gains rate would revert to 20% for most taxpayers and to 10% for those in the 15% income tax bracket in 2013. Qualified dividends, meanwhile, would go back to being taxed as ordinary income, so for some investors, the top tax rate could rise to 39.6%
Estate and gift taxes also were part of the 2001 tax cuts. For 2012, beneficiaries have to pay estate tax on amounts over $5.12 million at a top rate of 35%. The exemption is scheduled to revert to $1 million in 2013, and the top rate will increase to 55%.
The limitation on certain itemized deductions (known as Pease, named for the congressman who helped create the legislation) and the phaseout of personal exemptions (known as PEP, personal exemption phaseout) also need to be addressed. These provisions have the effect of further increasing the tax rate of people in higher income tax brackets. PEP and Pease are currently suspended, but they will come back in 2013 unless Congress acts.
A long list of other taxes could also be impacted. For example, without congressional action, the child tax credit will be reduced, and marriage penalty relief will expire, as will a host of tax benefits for education, adoption, and dependent care.
The prevailing sentiment among lawmakers in both parties, according to Knight, seems to be to avoid increasing taxes on middle-income households—but the definition of middle income hasn’t been agreed upon. The president defines it as single tax filers with incomes below $200,000 and joint tax filers with incomes below $250,000. Others have said the line should be drawn at $1 million, notes Knight. The real disagreement is about what happens to taxes affecting higher earners with incomes above these levels. However, if Congress and the president gridlock and fail to act, the tax cuts will expire for everyone—including middle- and lower-income families.
Many tax provisions have already expired and need to be extended
Several popular tax provisions expired at the end of 2011. These provisions
have routinely been extended in the past, but because of the tight budget
situation, lawmakers will be scrutinizing them more closely, and some of the
provisions may not be renewed. Here are a few of the items on the bubble:
New taxes from health care reform
How to prepare
All these tax provisions, and many others, will be in play as the end of the
year approaches and Congress debates how to address the nation’s budget
challenges. Rather than try to predict how the debate will turn out, your time
probably would be better spent focusing on sound tax planning that can serve you
well in multiple scenarios, says Buza.