Remember the unpronounceable TRUIRJCA of 2010 (see blogs from the past few days—The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010)? While some tax breaks vanish at the end of 2011, many of the Bush-era tax cuts remain for another year as part of the deal struck by Congress last December. Here are a few:
- Individual tax rates – The Bush tax cuts were destined to become history last December 31, 2010, but Congress rallied and extended the rates through December 31, 2012. Who could have guessed back in 2001 that the country would go through a massive recession and that lower tax rates might be needed just to enable families to keep a roof over their heads? But here we are – and the rates will remain at 10%, 15%, 25%, 28%, 33% and 35% for individuals for another year. The proposals to tax the “wealthiest Americans” would raise that 35% approximately 3-4% along with additional Medicare taxes.
- Capital Gains/Dividends tax rates – For lo, these many years, we have enjoyed a maximum capital gains rate of 15% on qualified dividends as well as on the sale of appreciated stock and most other capital assets [there is still a 28% gain rate on collectibles and 25% on Section 1250 recapture–depreciation]. And the news is even better if you are in the 10% or 15% tax brackets – there is actually a 0% tax rate on capital gains! (see our blog from December 3, 2010, “Yes Virginia, There Really is a 0% Cap Gains Tax Rate”). Granted – capital gains have been elusive for the past few years. But if Congress had not acted last year, the rates would have climbed to 20% — just in time for the Dow to break 12,000–again.
- PLANNING THOUGHTS – If your tax rate is 15% or lower, this might be a great time to harvest capital gains. If you don’t qualify, maybe your non-dependent adult children do – so a gift of appreciated stock this year or next has a bigger bang—remember that gifted stock bears the donor’s basis. Or how about this – do you have a long term shareholder loan out with your closely held corporation, S or C? Convert it – with advice from your tax professional!!! – to a dividend…potentially without taxation (or 15% at the highest). Get it off your books now before rates go up.
- FLIP SIDE – And what about installment sales – beware! If you sell an asset on the installment method, you are taxed on the capital gain you collect annually. Right now, that is 15%. But it could jump to 20% before the term runs on the installment contract thus exposing you to higher tax rates in future years.
- Itemized Deduction Limitation – Here is a stealthy tax presented in the first Bush era to tax, well, the wealthiest Americans. Yep–not a new idea. More and more of our clients have become subject to this tax over the years (due to inflation) and very few people noticed it because there was NO LINE on the tax return demonstrating the tax. It effectively reduced the deduction for mortgage interest, taxes (property and state) and charitable contributions. Here is how it worked – briefly: you put 100% of your deductions on Schedule A and then the software (or the IRS) subtracted a mysterious amount from the bottom line of the form (if you foot the form, it doesn’t foot…so 2 + 2 does not equal 4 on Schedule A from many prior year returns, but of course, it is quite complicated – see below for a much better example). The result of lower deductions is higher taxable income and higher tax. So, when Obama talks about reducing the deduction for charitable giving and mortgage interest, he is only resurrecting the old tax law but less smoothly than his predecessors. It has been going on for a very long time. The Bush tax cuts repealed this stealthy tax for 2010 ONLY and then it was coming back with a vengeance in 2011. Now, with TRUIRJCA of 2010, it remains repealed through 2012.
- Personal Exemption Phaseout – Another “gentle” way to tax higher income taxpayers was the personal exemption phaseout. Higher income taxpayers did not get to take a full (or any in some cases) exemption for themselves or their dependents. The Bush tax cuts repealed this phaseout for 2010 ONLY, but the TRUIRJCA of 2010 includes the repeal for 2011 and 2012. Now THIS is interesting: The Joint Committee on Taxation reports that higher income taxpayers will save approximately $20 billion (that is billion) from the repeal of the itemized deduction limitation combined with the personal exemption phaseout. So where is Congress going to get this money replaced – by cuts or by other taxes or ??? Food for thought.
PS – a good explanation of so-called “Pease Provision” – itemized deduction limitation (lifted from The Tax Foundation Special Report, April 2010 No. 178 — www.taxfoundation.org—thank you!):
“For example, if a couple had combined income of $100,000, they retained the full value of their deductions for mortgage interest, charitable gifts, etc. But if they earned $150,000, and their itemized deductions totaled $20,000, then the couple would have to subtract three percent of the earnings above the threshold from their deductions. In this case, three percent of $50,000 is $1,500, so their deductions would be shaved from $20,000 down to $18,500. When enacting the Pease provision, Congress decided not to allow it to completely wipe out a taxpayer’s deductions. Twenty percent of the deductions can be kept no matter how high the taxpayer’s income.”
My comment – oh, boy…20%. And then there is alternative minimum tax, too. Yes, we need a simpler tax code. Absolutely.
By the way, the $100K combined income has been indexed over the years. Obama Administration is proposing a threshold of around $255K for joint filers and $204K for singles, after 2012. Important thing to note – NO PEASE PROVISION for 2011 or 2012. Also to note – does it seem like there is a marriage penalty here?