Most of the tax cuts enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 will expire at the end of 2010 unless Congress acts to extend them. If the cuts do expire as scheduled, nearly three-quarters of Americans will pay more tax in 2011 and subsequent years. Observers expect that Congress will extend many of the cuts for most taxpayers but it's uncertain which provisions would continue for whom. President Obama has proposed letting the tax cuts
expire only for high-income taxpayers-couples with income above $250,000 and others with income over $200,000. Some members of Congress want to make all of the tax cuts permanent. Others would extend them all but only temporarily until the economy fully recovers from recession. And still others would let all of them expire as scheduled.
What will happen if Congress doesn't act to change current law?
Income taxes will rise:
- The 10 percent tax bracket will disappear and the 25 percent, 28, percent, 33 percent, and 35 percent rates will revert to 28 percent, 31 percent, 36 percent, and 39.6 percent respectively.
- The phase-out of personal exemptions and limit on itemized deductions will return for high-income taxpayers.
- The standard deduction and the width of the 15 percent tax bracket for married couples filing jointly will both shrink from twice that for single filers to 1.67 times as large.
- Dividends will be taxed at regular tax rates rather than at the lower long-term capital gains rates.
- Long-term capital gains tax rates will increase from 0 percent to 10 percent for taxpayers in the 15 percent bracket and below and from 15 percent to 20 percent for filers in higher tax brackets.
- The child credit will be halved to $500 and become largely non-refundable.
- The child and dependent care credit and the earned income credit will be pared back.
Many more taxpayers will pay the alternative minimum tax (AMT). In recent years, Congress has increased the exemption for AMT each year to keep the levy from affecting millions of taxpayers. Expiration of the 2001 and 2003 income tax cuts will reduce the impact of the AMT by raising regular taxes-people pay the AMT only if it exceeds their regular tax.
Still, if Congress doesn't continue to allow higher AMT exemptions, many more taxpayers will owe the alternative tax.
The estate tax will come back into existence under pre-2001 law. The 2001 tax cuts phased down the estate tax by raising the effective exemption-to $3.5 million in 2009-and lowering the tax rate-to 45 percent in 2009-before eliminating the tax entirely for 2010. Under current law, however, the exemption will fall to $1 million and the top tax rate will climb to 55 percent in 2011 and later years.
How would extending the 2001-2003 tax cuts affect average tax rates?
Extending all of the tax cuts-termed current policy-would reduce the overall average tax rate in 2012 from 23.5 percent under current law to 20.7 percent. The reduction would be roughly proportional across income percentiles.
The cash income percentile classes used in this table are based on the income distribution for the entire population and contain an equal number of people. The breaks are (in 2009 dollars): 20% $19,356, 40% $37,493, 60% $65,656, 80% $111,659, 90% $161,739, 95% $226,402, 99% $599,181, 99.9% $2,727,123
How would President Obama change income and estate taxes?
- Extend the 2001-2003 income tax cuts for low- and middle-income taxpayers.The president's budget would permanently extend all of the 2001-2003 tax cuts for couples with income under $250,000 and others with income under $200,000
- Raise income taxes on the rich.The president's budget would allow the 2001-2003 tax cuts to expire for couples with income over $250,000 and others with income over $200,000. The following changes would occur:
- The top two tax rates would increase from 33 and 35 percent to 36 and 39.6 percent.
- Long-term capital gains and qualified dividends would face a top tax rate of 20 percent.
- The reinstatement of the phase-out of personal exemptions (for married filing jointly beginning at $254,450 AGI and single at $203,550 AGI) and the limitation on itemized deductions would again affect high-income taxpayers. Because deductions reduce taxable income, their effect on tax liability depends on the taxpayer's tax bracket. For example, itemized deductions totaling $10,000 reduce taxes for a person in the 15 percent bracket by $1,500 (15 percent of $10,000) but cut taxes by $3,500 for a person in the 35 percent bracket (35 percent of $10,000). The president proposes limiting the value of deductions to no more than 28 percent starting in 2011. That limit would increase taxes for taxpayers whose tax rate exceeds 28 percent-those who would face 36 percent and 39.6 percent tax rates in 2011.
- Make 2009 AMT parameters permanent and index them for inflation. Since 2001, Congress has repeatedly increased the individual AMT exemption on a temporary basis to prevent too many taxpayers from being subject to the tax. Absent these stopgap measures, sometimes called "the patch," the AMT exemption would stay at the nominal levels established in 1993, and the AMT would affect almost a third of all taxpayers. The stimulus bill ("American Recovery and Reinvestment Act of 2009") extended the patch through 2009, setting the exemption level at $46,700 for single and head of household filers, $70,950 for married people filing jointly and qualifying widows or widowers, and $35,475 for married people filing separately. The AMT has two tax rates: 26 percent on the first $175,000 of income above the exemption and 28 percent on incomes above that amount. The President's proposal would remove a significant source of uncertainty about taxation and prevent inflation from pushing large numbers of taxpayers onto the AMT in future years. Most of the benefits of the change would go to taxpayers with relatively high incomes: about three-fourths of the tax cut in 2012 would go to households with income over $100,000. Over half of taxpayers with income between $200,000 and $500,000 would see their tax bills drop by an average of over $1,800, raising their after-tax income by more than 0.9 percent.
- Make the 2009 estate tax permanent and index for inflation. In 2001, Congress voted to phase out the estate tax gradually and repeal it entirely in 2010. However, unless the law is changed, starting in 2011 estates valued at $1 million or more would again be subject to tax at progressive rates as high as 60 percent. This extraordinary situation places great pressure on Congress and the President to reconsider the tax this year. The Obama budget assumes permanent extension of the estate tax under 2009 parameters as part of its baseline. Estates with a net value over $3.5 million or more would face a 45 percent tax rate. For married couples, a modest amount of tax planning would raise the exemption to $7 million.
Most of the tax cuts enacted in 2001 and 2003 will expire at the
end of 2010 unless Congress acts to extend them. Onlookers expect that Congress will extend many of the cuts for most taxpayers but it's uncertain which provisions would continue for whom. President Obama has proposed letting the tax cuts expire only for high-income taxpayers. It's hard to say at this point whether you will pay more taxes in 2011. However, with all this uncertainty in the tax laws, it is worth your while to stay on top of your financial position and your tax liability; especially, if you are a high-income tax payer. This will enable you to quickly and effectively respond to any tax changes made by Congress.
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Note: The information contained in this material represents a general overview of tax regulations and should not be relied upon without an independent, professional analysis of how any of these provisions apply to a specific situation.
Source: Tax Policy Center Urban Institute and Brookings Institution, August 2010