We have been talking a lot about the “Bush Tax Cuts” and that they expire the end of this year, but what are they?
Basically, the majority of the current tax structure is set to expire on December 31, 2012 unless Congress acts. The main areas that are expiring are the Bush Tax Cuts, the alternative minimum tax (AMT) patch, the temporary payroll tax cuts and other temporary expiring provisions, known as “tax extenders”. In addition, the new Medicare “kicker” taxes start in 2013 under “Obama Care”.
Since most of our writing through the rest of this year will be focused on these areas and the potential impact they have on you, we thought it would be a good idea to start with some basics of what is set to expire.
BUSH TAX CUTS
The Bush Tax Cuts encompass a large number of provisions and has been the tax structure we have operated under for the past 10 years. Basically, the Bush Tax Cuts lowered taxes for everyone in a variety of ways. Here are the major provisions of the Bush Tax Cuts that are set to expire:
- Tax rates for individuals. The Bush Tax Cuts reduced the tax rate for every individual. Under this tax structure the lowest tax rate is 10% and the highest 35%. If these provisions expire, ever American will pay increased taxes. The lowest rate increases to 15% and the highest to 39.6%. Additionally, every level of income would experience an increase in their marginal tax rate.
- Tax rates on capital gains and dividends. The Bush Tax Cuts reduced to tax rate on long-term capital gains and qualified dividends to a maximum rate of 15%. In some instances the tax rate is as low as 0% for “middle income” households. If these provisions expire, long-term capital gains would increase to a maximum tax rate of 20%, dividends would be taxed as ordinary income (meaning they would range from 15% to 39.6% depending on your income level) and the 0% tax rate would be eliminated.
- Limits on itemized deductions. Under the Bush Tax Cuts their is no limit on your itemized deductions (i.e. mortgage interest, taxes, etc.). If these provisions expire, your itemized deductions would decrease as your income increases (known as a phase out). Your itemized deductions will be reduced 3% of the amount exceeding a certain indexed threshold amount (presumably around $170k in 2013). The total amount of the reduction will not be reduced more than 80% of the allowable itemized deductions.
- Personal exemption phase-out. Under the Bush Tax Cuts there is no limit on the personal exemptions you can claim. If these provisions expire, your personal exemptions would decrease as your income increases (known as a phase out). Your personal exemptions will be reduced 2% for each $2,500 your income exceeds a certain indexed threshold amount (presumably around $260k for married taxpayers in 2013). There is no limit on the reduction, so the amount can go to zero if your income is to high.
- Child tax credit. Under the Bush Tax Cuts the child tax credit is $1,000 per eligible child with a portion of it being refundable based on household income. If this provision expires, the credit would be reduced to $500 per eligible child and the credit would not be refundable for most families.
- Adoption tax benefits. The Bush Tax Cuts significantly increased the tax benefit for adopting a child. If this provision expires it would severely limit this tax benefit.
- Dependent care tax credit. The Bush Tax Cuts increased the amount of tax credit taxpayers received for dependent care costs. If this provision expires the amount of the tax benefit will be reduced for all taxpayers.
- Marriage penalty. Under the Bush Tax Cuts inequality in the law for married couples was removed. If this provision expires the marriage penalty would be reinstated and middle income married couples would experience a tax increase.
- Estate and gift tax. The Bush Tax Cuts significantly the estate tax exemption and tax rate. Basically estates over $5,120,000 are taxed at a top tax rate of 35%. Gift limits are unified and portability between spouses was added. If these provisions expire, the estate exemption will be reduced to $1 million and the top tax rate will rise to 55%.
The Alternative Minimum Tax (AMT) was designed to ensure that higher-income taxpayers who owed little or no taxes under the regular income tax because they could claim tax preferences would still pay some tax. When calculating the AMT, taxpayers first add back various “tax preference items” (like certain deductions) to their taxable income, to determine the amount of income subject to the AMT (the “AMT tax base”). Second, taxpayers subtract a basic exemption amount from their AMT tax base. Third, a two-tiered rate structure of 26% and 28% is assessed against the AMT tax base to determine tax liability. Finally, if a taxpayer’s AMT is greater than their regular tax liability, the taxpayer pays the difference in addition to their regular tax liability (the difference paid is technically the AMT).
Unlike the regular income tax, key parts of the AMT—including the exemption amounts—are not indexed for inflation. This means in a typical year, as a result of inflation increasing taxpayers’ nominal income levels, additional taxpayers are subject to the AMT.
The Bush tax cuts temporarily increased the exemption amount under the AMT. This temporary increase in the exemption amount, known as the AMT patch, was extended several more times and was in effect through the end of 2011. In 2011, the AMT exemption amounts were $74,450 for married individuals filing joint returns and $48,450 for unmarried individuals.
These exemption amounts revert to $45,000 for married individuals and $33,750 for unmarried individuals in 2012. This means that an increased number of taxpayers will be subject to AMT unless Congress adjusts this exemption amount for 2012.
PAYROLL TAX CUT
The payroll tax cut was initially enacted for 2011 and extended through the end of 2012. This payroll tax cut reduced the employee’s share of Social Security payroll taxes. Specifically, the payroll tax cut reduced the employee’s share of Social Security taxes from 6.2% to 4.2% for employees and from 12.4% to 10.4% for the self-employed on the first $110,100 of wages in 2012. This provision expires at the end on 2012. It is our opinion that this provision will not be reinstated in 2013.
OTHER EXPIRING PROVISIONS & “TAX EXTENDERS”
There is a long list of short term tax provisions that are set to expire. The entire list is beyond the scope of this writing, but here are the major items that have expired or are set to expire at the end of this year.
- Individual provisions. The most notable of these items include the deduction for state and local sales taxes; the refund-ability of the credit for prior minimum tax liability; the above-the-line deduction for qualified tuition and related expenses; the deduction of mortgage insurance premiums as qualified interest; the expansion of the adoption credit and adoption assistance programs; the above-the-line deduction for certain expenses of elementary and secondary school teachers; and the parity in the tax treatment of employer-provided transit benefits to parking benefits.
- Business provisions. The most notable of these items include bonus depreciation in 2011 and 2012, whereby a 100% bonus depreciation allowance is in effect through the end of 2011, set to decrease to 50% for 2012 and expire after December 31, 2012; the research and experimentation credit; the exception under Subpart F for active financing income earned by banking, financing, and insurance business operations abroad; the enhanced cost-recovery for qualified leasehold, restaurant, and retail improvements; and the enhanced expensing allowances which allow businesses to expense $500,000 for investment in qualified investment in 2011, $125,000 in 2012, and $25,000 thereafter.
- Charitable provisions. The most notable of these items include tax-free distributions from IRAs for the purposes of charitable donations; enhanced charitable deductions for corporate contributions of computer equipment for education purposes; and enhanced charitable deductions for contributions of food inventory.
- Energy provisions. The most notable of these items include incentives for alcohol fuels (primarily ethanol); incentives for biodiesel and renewable diesel; the Section 1603 grants-in-lieu of tax credit; the placed-in service date for the production tax credit for wind; and the credit for nonbusiness energy property (sometimes referred to as the “25C credit”).
- Community development provisions. The most notable of these items include qualified zone academy bonds, which are available to state and local governments for elementary and secondary school renovation, equipment, teacher training, and course materials; the new markets tax credit (NMTC), which is designed to promote investment in low-income and impoverished communities; and tax incentives to encourage economic activity in empowerment zones, the District of Columbia (DC), and in the American Samoa.
- Disaster relief provisions. The most notable of these items include provisions designed to help redevelopment of the New York Liberty Zone and the Gulf Opportunity (GO) Zone, as well as provisions to provide relief following the Midwestern storms and Hurricane Ike in 2008.
We will keep you posted on the progress of these provisions and their movement through Congress. If you have any questions regarding these provisions, please do not hesitate to contact us.