July 20 Update – Bush Tax Cuts Reviewed

We all continue to read and hear about the main issues creating the volatility in the market which include the European Sovereign Debt Crisis and the inconsistency of the U.S. economic data. We continue to see signs that the Federal Reserve is likely to initiate more monetary policy stimulus to help produce growth. We also are pleased with the latest earnings reports from U.S. companies. Most reports came in better than expectations but in order for earnings to remain strong we will need to see some clarity on the macro issues in order restore confidence.

In the meantime we wanted to discuss the potential expiration of the Bush Tax cuts. It is our opinion that Congress will pass a last minute bill to extend many of the tax cuts because they understand that raising taxes in this economic environment could jeopardize our economic recovery.

Brad Combs has put together a good summary of the changes we would face if the Bush Tax cuts are not extended.

Overview

This may be the final year that the so-called Bush tax cuts remain in effect, unless Congress acts to further extend them. The Bush tax cuts, enacted in 2001 and 2003, were originally scheduled to expire for tax years beginning in 2011. However, President Obama signed legislation in late 2010 that temporarily extended the Bush tax cuts through 2012. Many commentators agree that Congress is unlikely to extend the Bush tax cuts prior to the November elections, but uncertainty remains as to whether Congress will take action following the elections. If Congress fails to extend the Bush tax cuts, many significant rate changes and other substantive changes will take effect in 2013.

Some highlights of the tax changes that could take effect if the Bush Tax cuts are not extended include:

  • Additional Medicare Hospital Insurance (HI) tax of .9% (total of 2.35% for employee portion) on earned income above $200,000 single/$250,000 married filed jointly. This will take effect in 2013 regardless of whether Congress extends the Bush tax cuts.
  • 3.8% Medicare Contribution tax on unearned income for amounts above income threshold of $200,000 single/$250,000 married filed jointly. Unearned income includes interest, dividends, rental income, and capital gains. This will also take effect regardless of whether Congress extends the Bush tax cuts.
  • Ordinary Income tax rates increase:
    •  Top bracket of 35% increases to 39.6%
    •  33% bracket increases to 36%
    •  28% bracket increases to 31%
    •  25% bracket increases to 28%
    •  10% bracket increases to 15%
  • The marriage penalty returns – decreased standard deduction on tax return. Itemized deductions will once again be limited for higher income taxpayers.
  • Long term capital gains rates increase from 15% to 20% (23.8% with surtax). Assets purchased after 2000 and held for 5 years will be taxed at 18% rate (21.8% with surtax).
  • Dividend income would be taxed at ordinary income tax rates (qualified dividends currently taxed at favorable capital gains rate). Therefore those in highest tax bracket may be taxed as high as 43.4% on dividends when including 3.8% Medicare contribution tax.

We are hopeful Congress will act to avoid these tax changes. As the year progresses we will discuss tax strategy with clients and their CPAs. We will also be putting more detailed information on our NEWLY IMPROVED WEBSITE on this topic.