TAXES – Where they are. Where they are headed. Will they get there?

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by Jim Wagoner, Partner | Director, Tax Services Group

Well, here we are in the second half of 2010 and still nothing coming from Congress on what they will do with the income tax rates that will sunset at the end of 2010. In fact, Congress is going into August recess, the effects of the sunset provisions to many taxpayers that will take place starting January 1, 2011, if no action is taken soon.

In 2001 and 2003, the GOP Congress enacted several tax cuts for investors, small business owners and families. These tax cuts will all expire on January 1, 2011.

Personal income tax rates will rise. The top tax bracket will rise from 35% to 39.6% and the lowest tax bracket will rise from 10% to 15%. Keep in mind; these are the tax rates that most small business profits will be taxed at as well.

The table below is for married filing jointly.

Taxable Income 2010 2011 – 2012 With Surtax 2013 (1)

$0 – 16,750

10%

15%

15%

$16,750 – 68,000

15%

15%

15%

$68,000 – 137,300

25%

28%

28%

$137,300 – 209,250

28%

31%

34.8%

$209,250 – 373,650

33%

36%

39.8%

Over $373,650

35%

39.6%

43.4%

(1) Starting in 2013, the health care reform package broadens the Medicare tax base for higher-income taxpayers by imposing an additional tax rate of .9% on earned income in excess of $200,000 for individuals and $250,000 for married couples filing jointly; and imposes a 3.8% ‘unearned income Medicare contribution’ tax on higher-income taxpayers.

Itemized deductions and personal exemptions will again phase out, which has the same effect as higher marginal tax rates. The ‘marriage penalty’ (narrower tax brackets for married couples) will return. The child tax credit will be cut in half from $1,000 to $500 per child. The standard deduction will no longer be doubled for married couples relative to the single level. The dependent care and adoption tax credits will also be cut.

Capital gains rates will take a hike. The capital gains tax will rise from 15 percent this year up to a maximum of 20 percent in 2011. The dividends tax will rise from 15 percent this year to 39.6 percent in 2011. Then keep in mind that these rates will rise another 3.8 percent in 2013, as discussed above.

Will the estate tax return? In 2010, there is no estate tax. For those dieing on or after January 1, 2011, there will be a 55% top estate tax rate on estates over $1 million. There is speculation that we will see a one or two-year extension of the 2009 law ($3.5 million credit, 45% rate), but a question still looming is whether the new law with be retroactive back to January 1, 2010.

Alternative Minimum Tax (AMT) trap. It is estimated that AMT will affect approximately 28 million taxpayers, up from 4 million last year. This is because Congress has failed to index the AMT exemption. Most taxpayers, along with their tax practitioners, will have to calculate their tax burden twice and pay the higher tax burden. This is a ‘mandatory maximum’ tax, not an ‘alternative minimum’ tax.

Tax Planning Suggestions. For higher income taxpayers, it is almost a certainty that rates will be higher in 2011 than 2010, so consider accelerating income into 2010 and deferring year end tax deduction opportunities into 2011, unless you anticipate you will have substantially lower taxable income in 2011. With respect to unrealized capital gains, it may be more beneficial to convert these to realized gains at a 15% rate in 2010, rather than incur higher tax rates after 2010 on these gains. We believe that the Estate Tax will resurrect in some form similar to the 2009 rules, so in redrafting current wills, we would suggest including credit shelter trust provisions in your wills if your estate is significant (what does that mean? Depends on what congress does – if they revert to only a $1 million exemption, that would be your measuring point;  if they revert to 2009 rules, then estates of $3.5 million and over should have credit shelter trust provisions). Starting in 2011, higher income taxpayers should consider converting to tax-exempt or tax-deferred investments.

Well, now you know where the tax rates stand for 2010 and where they are headed for starting in 2011. But will Congress and the President act before the end of the year to restructure the tax brackets or extend the Bush tax cuts? The Tax Services Group at Greenwalt CPAs is staying on top the latest tax law news and will provide you with relevant and timely information as it is released.

Please be sure to check out our firms’ tax seminar series for topics which may be of interest to you. It can be seen at www.greenwaltcpas.com (you will see a link for the seminar series at the top of the screen).