PART I
September 8, 2010
Dear Client:
In an effort to keep you informed on tax law changes, we would like to address the significant changes which will occur when the so-called Bush Tax Cuts are sunset in 2011. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) will cease to be law at the end of this year. Absent legislative action, automatic sunset provisions in the law will reset 66 important income tax provisions to their pre-2001 level.
We would like to highlight several of these sunset provisions which may affect you, and summarize some of the tax law changes related to the current budget proposals of the Obama Administration. We will be sending a second letter to you on this issue which will include those provisions we believe have an opportunity to be extended in some form by an Act of Congress prior to year end.
In this first letter we are going to address issues which require significant legislative action to change and at this time appear unlikely to be reinstated into law prior to 2011.
Higher Income Tax Rates
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Table 2
Tax Rate Changes |
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2010 Rates |
|
2011 Rates |
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10%
15%
25%
28%
33%
35% |
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15%
15%
28%
31%
36%
39.6% |
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|
|
|
|
One common misconception about the elimination of the Bush Tax Cuts is that this elimination will only affect high-income individuals. This is not true as the following chart indicates. Beginning in 2011, if no legislative action is taken, we will see higher tax rates at every tax bracket level, not just the top brackets.
The Administration has proposed keeping the three lowest brackets (the 10%, 15%, and 25%) in place. The 28% bracket would be expanded to include unmarried taxpayers with income below $200,000 and joint filers with income below $250,000. Taxpayers with income above these levels will be subject to the 36% and 39.6% rates.
Higher Capital Gains Taxes
Currently, most long-term capital gains are taxed at a maximum rate of 15%. If a person is subject to an ordinary income tax rate below 25%, the long-term capital gain rate is actually zero percent. If no legislative action is taken, beginning in 2011, long-term capital gains will be taxed at a 20% tax rate.
The Administration has proposed leaving long-term capital gains at 0% and 15% rates for all persons except for married couples with income above $250,000 and unmarried individuals with income above $200,000. For this group of taxpayers, the Administration has proposed a long-term capital gains rate of 20%.
Higher Tax Rates for Dividend Income
Qualified dividends are currently taxed at the same 15% tax rate that applies to long-term capital gains. Dividends paid to individuals will be taxed at the same rate that applies to ordinary income (see Table 1 below). This means the maximum rate on dividends will be 39.6% (a tax increase for high income persons of 264% for dividend income).
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Table 1
Income tax Rates on 2011 Dividend Income |
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Single Taxable Income |
Tax Rate for 2011 Dividends |
Married Taxable Income |
Tax Rate for 2011 Dividends |
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$0-34,550
$34,550-$83,700
$83,700-$174,650
$174,650-$379,650
$379,650 and above |
15%
28%
31%
36%
39.6% |
$0-$57,700
$57,700-$139,500
$139,500-$212,600
$212,600-$379,650
$379,650 and above |
15%
28%
31%
36%
39.6% |
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*The tax rate for dividends in 2010 is a flat 15% for all taxpayers. |
Marriage Penalty Will Get Worse
Currently, the size of the 10% and 15% brackets for married couples filing joint is 200% of the size for single taxpayers in the same tax brackets. Similarly, the standard deduction for married couples filing jointly is 200% of the standard deduction for single taxpayers. The EGTRRA put these favorable provisions for married individual in place in order to diminish the so called marriage penalty, which can cause a married couple to pay more federal income tax than if they filed as two single taxpayers.
Starting in 2011, the 15% tax bracket for married filing jointly taxpayers will be only 167% the size for single taxpayers in the same tax bracket. For married filing separate taxpayers the bracket will be 83.5% of the size for single taxpayers in the same bracket. Similarly, the new standard deduction for joint filers will only be 167% of the standard deduction allowed for single filers.
The Administration has proposed leaving the standard deduction for married taxpayers filing jointly at 200% of the standard deduction for single taxpayers. For high income individuals who generally itemize their deductions, this proposal will provide no tax benefit.
Itemized Deduction and Personal Exemption Phase-out Rules Will Return Resulting in Increases in Your Tax Liability
Before the tax cuts of 2001 and 2003, a rule existed which could eliminate up to 80% of itemized deductions for higher-income individuals (thus increasing their taxable income). The rule reducing deductions covered itemized deductions for mortgage interest, state and local taxes, and charitable deductions.
A similar rule reducing the personal exemption deduction for higher income individuals also existed prior to the EGTRRA tax cut. The EGTRRA tax cut gradually reduced and finally eliminated both rules reducing these tax deductions in 2010. The elimination of the EGTRRA tax cut will result in higher income individuals losing a significant portion of their itemized deductions and personal exemption deductions.
The Administration has indicated that it wishes to keep the EGTRRA tax cut but for only lower tax bracket persons.
What Should you Expect?
Any way you look at the tax laws, 2011 will be a year of major tax changes. It appears little legislative action will be taken to address these issues before the November elections according to our contacts with the Senate Finance Committee. This will likely delay tax planning to the very end of the year for you.
If you have any questions regarding this information, or if you would like to discuss your specific situation in further detail, please call us at your convenience.
PART II
November 3, 2010
Dear client:
We recently sent you a letter regarding changes to the tax law that will occur when the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), also known as the Bush Tax cuts, expires at the end of the year. We would like to take this opportunity to inform you of other provisions that are set to expire at the end of this year, but are likely to be extended for another year. These provisions are commonly called "extenders." Congress most likely will act on these at the end of this year or early next year.
Alternative Minimum Tax:
The Alternative Minimum Tax (AMT) exemption is a common extender provision. The provision exempts many taxpayers from being subjected to the AMT. The table below describes the current status of the AMT exemption and what the Administration has proposed for the exemption amounts for the next two years. The AMT exemption is subject to a phase-out for certain taxpayers. The Administration has proposed increasing the threshold from $112,500 to $112,700 for unmarried taxpayers and from $150,000 to $150,250 for married filing joint taxpayers for 2010. In 2011 the threshold would be expanded to $115,400 and $153,850 for unmarried and married filing joint taxpayers, respectively.
Alternative Minimum Tax Exemption Amount
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Current Law Status
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Administration Proposals
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| Filing Status |
2009
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2010
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2010
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2011
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Unmarried
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$46,700
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$33,750
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$46,750
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$47,900
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Married Filing Joint
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70,950
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45,000
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71,050
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72,750
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Married Filing Separately
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35,475 |
22,500
|
35,525
|
36,375
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Child Tax Credits:
Many taxpayers with children are well aware of the child tax credit. This credit was expanded from $500 to $1,000 per eligible child when the EGTRRA was passed in 2001; however, when the law sunsets at the end of 2010, the child tax credit will revert to $500 per eligible child.
The Administration has proposed to permanently extend the $1,000 child tax credit and allow the credit to offset the taxpayer's regular income tax as well as AMT.
Dependent Care Credit:
Currently, the maximum dependent care tax credit is $1,050 for one eligible child and $2,100 if there are two or more qualifying children. The credit is calculated by multiplying 35% times the eligible expense up to $3,000 and $6,000, depending on the number of qualifying children. The credit is partially phased out to 20% of eligible expenses when a taxpayer's AGI exceeds $43,000. At the end of 2010 the credit percentage, credit base, and maximum credit are all reduced. However, the Administration has proposed permanently extending the dependent care credit at its current level.
Other:
Other extender items likely to be extended at their current levels are the adoption credit/exclusion, the employer provided child care tax credit, and the above the line deduction for qualified tuition and fees.
Conclusion
These tax provisions have a greater chance of being extended for 2011, than the provisions discussed in our previous letter. These provisions still require legislative action, but history has shown us that Congress typically extends and modifies these items. As we have said before, these extender items will most likely not be addressed until after the November election. We will continue to keep you informed of significant tax law changes that may affect you.
If you have any questions regarding this information, or if you would like to discuss your specific situation in further detail, please call us at your convenience.
