The Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 (TRUIRJCA) extended the so-called “Bush-era tax cuts” that were set to expire on December 31, 2010, for two years. This article provides a historic look at the Bush-era tax cuts, divulges what will happen when and if these cuts are allowed to expire on December 31, 2012 and offers an option to those who opposed the two-year extension.
Bush-era tax cuts generally refers to certain provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). Both of these laws, passed during the presidency of George W. Bush, generally reduced individual taxpayers’ tax rates.
One of the more notable characteristics of EGTRRA is that its provisions were designed to sunset on January 1, 2011. On that date, the tax provisions that were in effect before EGTRRA would be restored.
Also known as Public Law 107-16, EGTRRA lowered tax rates, reduced estate and gift taxes and simplified retirement and qualified plan rules. Many of the EGTRRA tax reductions were designed to be phased in over a period of up to nine years.
- Income tax
EGTRRA generally reduced individual income tax rates by creating a new 10 percent bracket at the lowest income level and reducing the rates in higher brackets as follows: 28 percent lowered to 25 percent; 31 percent lowered to 28 percent; 36 percent lowered to 33 percent; and 39.6 percent lowered to 35 percent.
EGTRRA increased the standard deduction thereby attempting to mitigate the so-called marriage penalty for joint filers to double the amount for single filers and expanded the size of the 15-percent tax bracket for married taxpayers to double the income amount that applies to single filers.
Additionally, EGTRRA increased the per-child tax credit and the amount of the credit for dependent child care. It phased-out limits on itemized deductions and personal exemptions for higher-income taxpayers and increased the exemption for the alternative minimum tax (AMT).
The capital-gains tax on qualified gains from the sale of property or stock held for five years was reduced from 10 percent to eight percent.
- Estate and gift tax
EGTRRA made sweeping changes to the estate tax, gift tax and generation-skipping transfer tax rules.
The estate tax unified credit exclusion, which was $675,000 in 2001, was increased to $1 million in 2002, $1.5 million in 2004, $2 million in 2006 and $3.5 million in 2009. The estate tax and generation-skipping tax was repealed effective January 1, 2010.
The maximum estate tax, gift tax and generation-skipping-tax rate, was 55 percent in 2001, with an additional five percent for estates over $10 million. EGTRRA reduced the rate to 50 percent in 2002, with an additional one percent reduction each year until 2007, when the top estate-tax rate became 45 percent.
The state estate tax credit, which effectively gave the states a part of the estate tax otherwise payable to the federal government, was phased out between 2002 and 2005 and replaced by a deduction for state estate taxes beginning in 2005.
The gift tax was not repealed and the unified credit exclusion remained at $1 million. However, the maximum gift-tax rate was reduced to 35 percent beginning in 2010.
With the repeal of the estate tax in 2010, new carry-over basis provisions were enacted that would increase the income tax on capital gains realized by some estates and heirs.
Public Law 108–27, also known as JGTRRA, removed much of the wait and accelerated the tax-lowering effects of EGTRRA. It also increased the AMT exemption and lowered tax rates on dividends and capital gains.
- Income tax
The tax rate decreases — originally scheduled to be phased into effect in 2006 under EGTRRA were retroactively — enacted to apply to the 2003 tax year. The child tax credit was increased to what would have been the 2010 level and marriage penalty relief was accelerated to 2009 levels.
In addition, the capital gains tax rates were lowered from eight percent, 10 percent and 20 percent to five percent (zero percent in 2008) and 15 percent. Also, taxes on qualified dividends were reduced to capital gains levels.
By significantly lowering the marginal tax rates for almost everyone, many more individuals became subject to the AMT. As a result, the benefit of the two acts was mitigated for many upper-middle income individuals, particularly those with deductions for state and local income taxes, dependents and property taxes. To avoid the increasing impact of the AMT, Congress has had to regularly enact an increase in the AMT exemption.
TRUIRJCA, otherwise known as Public Law 111–312, extended many of the sunset provisions of EGTRRA/JGTRRA until December 31, 2012.
What Happens January 1, 2013
What happens on January 1, 2013 depends on the U.S. Congress. Senators and Members of the House of Representatives are likely to propose numerous tax law changes during the next two years. The best one can do at this point in time is to look at what will happen in 2013 in the absence of further Congressional action.
Much of the same debate that took place in the waning months of 2010 likely will be resurrected in 2012, although it is possible the estate tax situation will have been settled. But the 2012 debate will have an added dimension. As January 1, 2013, approaches, Congress and the electorate will once again face the tax increases that will result from the sunset provisions of the Bush era tax cuts. Also looming on the horizon will be the already-enacted tax rate increases from the Patient Protection and Affordable Care Act (Public Law 111–148) that the Health Care and Education Reconciliation Act (Public Law 111–152) amended.
Changes expected in 2013 as a result of the sunset provisions include:
- Tax rate increases
Beginning January 1, 2013, the top tax rate will rise more than 13 percent, from 35 percent to 39.6 percent. At the same time, the maximum tax rate on long-term capital gains will go from 15 percent to 20 percent — a 25-percent increase. And the maximum tax rate on qualified dividend income, currently capped at 15 percent, will increase to 39.6 percent (a whopping 164 percent rise), since dividends will be taxed like other ordinary income.
- Marriage penalty returns
In 2013, the standard deduction for married taxpayers will cease to be calculated as 200 percent of the amount available to unmarried filers. Instead, it will return to a level of about 167 percent of the unmarried amount.
- Phase-outs restored
For 2011 and 2012, higher income individuals will not be subject to the “Pease limitation,” which reduced the available itemized deductions for those with income above a threshold. The adjusted gross income (AGI) threshold was set at $100,000 ($50,000 for married individuals filing separately) in 1991. The threshold is adjusted annually for inflation. Beginning in 2013, the Pease limitation is scheduled to return. By 2013, the inflation-adjusted threshold is expected to approach $170,000.
Similarly, higher income individuals in 2011 and 2012 are not subject to the phase-out calculation that reduces or eliminates the exemption deduction. In 1991, the AGI threshold was set at $150,000 for married individuals filing joint returns and surviving spouses, $125,000 for heads of households, $100,000 for single individuals and $75,000 for married persons, filing separately. By 2013, the inflation-adjusted thresholds are expected to approach $255,000 for married couples and $170,000 for single individuals.
Whatever Congress decides to do with the sunset provisions, a new Medicare Hospital Insurance (HI) tax is scheduled to apply to high-income taxpayers, beginning January 1, 2013. The tax is 0.9 percent of earned income in excess of $200,000 for single filers and $250,000 for couples filing joint returns. An additional tax at the rate of 3.8 percent applies to investment income for the same individuals. This new tax will be paid with the annual income tax return. It is not collected through the withholding/deposit system that applies to the existing HI tax.
In addition, the threshold for the itemized deduction for unreimbursed medical expenses is scheduled to increase to 10 percent of AGI beginning January 1, 2013. If an individual or their spouse on a joint return turns 65 or older before the end of the tax year, the threshold will remain at 7.5 percent of AGI for the years 2013 through 2016.
Do You Have to Accept the Tax Cut?
In the debate leading up to the passage of TRUIRJCA, President Obama had originally proposed extending the Bush era tax cuts only for those earning less than $200,000 to $250,000 per year. The post-election Republican leadership in Congress wanted the tax cuts made permanent for everyone. The compromise is the two-year extension to December 31, 2012.
During the debate, many high-profile — and wealthy — individuals expressed support for allowing the tax cuts to expire for higher-income taxpayers, including themselves.
Those who believe they do not need or want the extended tax savings, have at least two choices:
1. Contribute the tax savings to the federal government
Those who believe the federal government is in the best position to redistribute the unwanted tax savings can make a general donation to the United States (U.S.) government. The U.S. Treasury maintains a specific account called "Gifts to the United States." This account was established in 1843 to accept gifts from individuals wishing to express their patriotism to the U.S. Money deposited into this account is for general use by the federal government and can be made available for budget needs. These contributions are considered an unconditional gift to the government. Check or money order financial gifts can be made payable to the United States Treasury and mailed to:
2. Contribute the tax savings to charity
Those who wish to decide for themselves the best use of their unwanted cash can select among any number of charities organized to further particular goals.
By temporarily extending the Bush-era tax cuts, rather than allowing them to expire or making them permanent, Congress has kept the tax law in a state of flux. With additional tax increases scheduled to coincide with the new expiration date, Congress may have raised the political and economic stakes for the next decision date. Those who object to receiving an extended tax benefit have the option of giving the money away.
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