In 2001 and 2003, some convoluted political maneuvering by Congress resulted in a series of tax cuts that came with an expiration date. Known familiarly as the “Bush tax cuts,” these provisions are set to end on December 31, 2010. If no new legislation is approved, tax rates that were in effect prior to 2001 will return.
Some of the highlights (or lowlights) of what a return to 2001 tax rules would mean:
• Higher Income Tax Rates – for everyone. The top income tax rate would revert to 39.6%, and the special low 10% bracket would be eliminated.
• A Revival of the Estate Tax. For individuals dying in 2010, there is no federal estate tax. In 2011, the estate tax returns with a $1,000,000 exemption and a 55% maximum rate.
• An Increase in Capital Gains and Dividend Tax Rates. The maximum long-term capital gains tax rate goes back up to 20% from 15%. A lower 10% tax rate is used by individuals who are in the15% tax bracket is eliminated. In addition, all dividend income (other than capital gain distributions from mutual funds) is taxed as ordinary income at your highest marginal tax rate.
• A Reduction in the Child Tax Credit. The credit of $1,000 per eligible child reverts to $500 after 2010. After 2010, none of the child tax credit will be refundable to taxpayers unless their earned income is more than $12,550.
• A Reinstatement of the so-called "marriage penalty." Some married couples filing jointly in the 15% tax bracket could have a higher tax bill since the standard deduction for couples filing jointly would again be less than double the deduction for single filers.
• Dollar limits will be placed on itemized deductions and personal exemptions. In contrast, there are no limitations for 2010.
The political debate to extend the tax cuts, allow them to expire, or enact new legislation has been spirited. Some argue that deficit reduction can only come about through higher taxes, while others fear a double-dip recession in the economy if more taxes are applied. Many observers expected compromise legislation this summer, since reinstating the 2001 tax provisions would violate promises by some politicians not to raise taxes for anyone with adjusted gross incomes below $250,000. But with the November elections looming and tax increases decidedly unpopular with voters,
Congress seems inclined to wait to address the issue as late as possible, making last-minute legislation a strong possibility. The consensus from most commentators is that some compromise will eventually be reached, but opinions about the specifics vary greatly.
While a long-standard nugget of financial wisdom asserts that no investment decision should ever be made based exclusively on taxes, the reality is that taxes impact almost every financial transaction. The uncertainty about what may transpire in regard to taxes leaves individuals hanging. Should a profitable investment be sold before December 31 to minimize the capital gains tax? Should 401(k) contributions be deferred until next year, when the resulting deduction might be higher? Are current estate plans still valid?
The only general response that makes sense for individuals in the face on these unknowns is to pay attention, keep some resources in reserve, and stay in touch with your financial and tax professionals regarding potential changes to your accounts and strategies.
AS 2010 COMES TO A CLOSE, MAKE SURE TO CHECK THE TAX STATUS OF YOUR ACCOUNTS, AND CONSIDER IF CHANGES SHOULD BE MADE FOR 2011.
(Disclaimer: we do not provide professional tax advice. Please check with your tax professional regarding your situation.)