As the calendar year winds down, it is the time to consider certain provisions of the current Internal Revenue Code set to expire Dec. 31 (barring some act by our friends in Washington, D.C.). Although it seems we have this song and dance just about every year, it may be particularly important to pay attention as 2012 comes to a close, since just about every tax cut enacted since 2001 is set to expire.
A recent report by the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution with nationally recognized experts in the field, likens this imminent tax cut expiration to a "fiscal cliff" over which our country could topple, because the average federal tax rate would increase from 19 percent to 24 percent and the average taxpayer burden would increase by approximately $3,500 per household. Here are some of the highlights.
- The current 15 percent tax rate on long-term capital gains income will expire, and long-term capital gains income will be taxed at 20%. On top of that, the 2010 Affordable Care Act imposes an additional 3.8 percent tax on the capital gain income of certain "high-income" households ($250,000 of adjusted gross income for married couples and $200,000 for others), resulting in a 8.8 percent increase.
- The Alternative Minimum Tax exemption amount will decrease from its current level of $74,450 for married household filers to $45,000; for single filers, it will drop from $48,450 to $33,750. Households whose income exceeds the lower thresholds would be required to calculate both their "regular" tax liabilities and Alternative Minimum Tax liabilities and pay the higher amount. This change is expected to subject tens of millions of taxpayers to increased Alternative Minimum Tax liability.
- Marginal tax rates will increase, as shown in the accompanying table.
- The standard deduction for married filing jointly households will be reduced from $12,100 to $10,150.
- Families with children under age 17 will lose half of the child credit (it is being reduced from $1,000 to $500) and will get smaller earned income and child care credits.
- Certain qualified dividends received by individuals will be treated as ordinary income and will no longer be eligible to be taxed at the long-term capital gains rate. That change, along with the additional 3.8 percent tax on dividend income imposed by the 2010 Affordable Care Act, could mean that households with the highest incomes would pay as much as 43.4 percent.
- Most itemized deductions will be reduced to the lesser of 3 percent of adjusted gross income above an inflation-adjusted threshold or 80 percent of the amount of itemized deductions otherwise allowable. The inflation-adjusted threshold is projected to be approximately $174,450 in 2013 for all taxpayers except married filing separately households.
- The employee portion of FICA taxes will increase from 4.2 percent to 6.2 percent.
- The current $5.12 million lifetime gift tax exemption is set to expire at year-end, reverting to a $1 million exemption for 2013 and beyond. In addition, the top gift tax rate rises sharply from 35 percent to 55 percent after Dec. 31.
The Tax Policy Center's report predicts that the FICA tax increase and the tax increase on "high income" households under the 2010 Affordable Care Act (with a possible exception if there is an administrative change come November) will very likely occur. President Barack Obama has repeatedly advocated for extending the Bush-era tax cuts for all taxpayers except "high-income" households, but the Republicans want to extend those cuts for everyone.
President Obama is in favor of allowing the favorable tax rates for capital gains and dividends to expire, and the Democratic majority in the Senate also has supported that, so it stands to reason that those tax cuts may expire in 2013.
President Obama, Mitt Romney and party leaders in Congress all favor a reduction of the estate tax and fix or elimination of the Alternative Minimum Tax, so Congress may find a way to at least preserve the current status quo on those points.
It is generally safe to assume that Congress will not take action on these issues until after the election. So for now we should be considering the available tax provisions and can only speculate how this will play out, understanding that we will probably have greater certainty after Nov. 6.
Jeffrey H. LaBarge is a partner with Nixon Peabody LLP.10/26/12 (c) 2012 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email firstname.lastname@example.org.