It seems like only a year ago that Congress and President Obama were at loggerheads over the pending expiration of the so-called Bush-era tax cuts. Now both sides are at an impasse over closing a $1.2 trillion budget gap, as evidenced when the so-called Super Committee opted for sequestration over compromise.
As usual, your clients are asking for advice: “What kind of tax policy should I expect for 2012 and 2013?”
What are you going to tell them? “Get ready for a National Sales Tax?” or “Get Ready for a Value Added Tax?”
Realistically, no one can predict the outcome of the current tax debate. The best CPAs can do is focus on what will happen in 2012 and 2013, in the absence of further Congressional action. It seems unlikely that Congress will be able to agree on any significant tax changes during the next 12 months.
What Happens January 1, 2012?
The payroll tax reduction, temporarily enacted for 2011, is scheduled to expire January 1, 2012. Absent further Congressional action, employees will see a reduction in their take-home pay, reflecting the return of the Social Security payroll tax rate to 6.2 percent from the 4.2 percent rate applicable to employees for 2011. President Obama has proposed an extension of the payroll tax cut into 2012 at a 3.1 percent rate on employees, instead of the 4.2 percent rate that was in effect for 2011. But the proposal so far lacks the necessary Congressional support.
What Happens January 1, 2013?
Effective January 1, 2013, the Bush-era tax cuts are scheduled to expire. 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 33 percent increase. And the maximum tax rate on dividend income, currently capped at 15 percent, will increase to 39.6 percent (a 164% 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 are not 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, 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, filing joint returns and surviving spouses, $125,000 for heads of households, $100,000 for single individuals and $75,000 for married, filing separately. By 2013, the inflation-adjusted thresholds are expected to approach $255,000 for married couples and $170,000 for single individuals.
- Estate tax changes
Effective January 1, 2013, the estate-tax exemption is scheduled to drop from more than $5 million back to $1 million and the maximum estate-tax rate is scheduled to rise to 55 percent. The estate-tax changes agreed to at the end of 2010 were only set in place for two years.
- New Medicare tax
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.
- Medical deduction threshold
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. In tax years 2013 through 2016, if an individual, or his or her spouse on a joint return, has turned age 65 before the close of the tax year, the threshold will remain at 7.5 percent of AGI.
As you try to advise your clients on the future tax landscape, here is a short list of political factors to keep in mind:
- High unemployment
As political leaders present competing solutions to the high-unemployment rate, the possibility of stagnation looms large, at least until after the 2012 election. So far, President Obama’s proposed extension of the payroll tax cut into 2012 has not gained traction in Congress. The only piece of the president’s jobs package that Congress has passed is a temporary extension of the Work Opportunity Tax Credit (WOTC) for hiring certain veterans.
- Debt and deficits
Will the two major political parties find a common ground on the $1.2 trillion budget gap? Or will both decide to wait until after the 2012 election, hoping their power base will be enhanced by the voters?
- Political gridlock
Can Congress agree to accomplish anything in an election year?
It is easy for politicians to label a tax bill as a “reform” measure. And it is easy to announce that loopholes are being closed. But one person’s loophole is often another person’s tax incentive.
A famous writer once said, “Everybody talks about the weather; but no one does anything about it.” The same might be said for elected officials and taxes.
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