• At year’s end, a slew of tax changes
     | November 11,2012

    Americans’ taxes will rise in a few weeks. Though the direction is clear, the exact amount is yet to be determined.

    More than a dozen tax cuts are set to expire and a couple of new taxes are scheduled to land on Dec. 31. Combined, they would affect nearly 90 percent of taxpayers, from the very richest to the very poorest, with the typical household’s tax bill rising by about $2,000 in 2013, according to the nonpartisan Tax Policy Center. One-percenters would see their taxes rise an average of $121,000.

    On Tuesday, Congress will reopen discussions about how to deal with the combination of spending cuts and tax increases looming at year’s-end, and maybe even dip a toe into a broader tax overhaul.

    “It would be bad for the economy and it would hit families that are already struggling to make ends meet,” President Barack Obama said on Friday of the scheduled increases in taxes. “While there may be disagreement in Congress over whether or not to raise taxes on folks making over $250,000 a year, nobody — not Republicans, not Democrats — want taxes to go up for folks making under $250,000 a year.”

    While legislators are expected to try to reverse or temper many of the scheduled tax increases, at least a few appear to be a fait accompli. Accountants and tax lawyers are expecting a flurry of frantic calls in the last few weeks of this year as clients rearrange their affairs to minimize the blow.

    “I don’t expect to have any respite from now till the end of the year,” said Robert Willens, the president of his tax and accounting practice in New York. “Clients are very concerned and kind of confused about what to do, whether they should be taking any affirmative steps or waiting to see what happens.”


    At least two categories of tax increases are widely expected to materialize in some form.

    A payroll tax cut given in the 2011 and 2012 calendar years — which was intended as a temporary stimulus — is set to expire, and so far both Democrats and Republicans seem ready to let that happen, although there could be some provision made to ease the pain for the lowest-earners.

    The lapsing payroll tax cut affects everyone who works, or about three-quarters of all tax filers. A household in the middle quintile, roughly between $40,000 and $65,000, could expect its taxes to rise by an average of $672 next year, while a household in the top quintile, being paid more than $108,000, would pay an average of $1,950 more, according to the Tax Policy Center.

    With the re-election of Obama, the taxes imposed by his health care overhaul will also almost certainly remain.

    Starting in 2013, high-income Americans will pay an additional tax of 0.9 percent on their earnings above $250,000 if they are married and above $200,000 if filing singly. These households will also pay an additional 3.8 percent on capital gains, dividend and interest income over those same thresholds. The average household in the top income quintile — the group of Americans most likely to be hit by these new taxes — would owe an additional $1,141.


    The fate of the other scheduled tax increases is less clear. Obama has advocated for some of them, but the Republicans, who control Congress, have opposed them.

    In particular, Obama wants to let lapse the lower rates begun in the Bush era on income, capital gains and dividends for higher earners, whom he has defined as those earning more than $250,000 for married couples and $200,000 for others.

    These tax rates were previously set to expire at the end of 2010, and were given a two-year extension. Letting them expire at the end of this year would raise an additional $52 billion in 2013.

    Allowing the income tax rates for high-earners to lapse would mean that, for married couples, income over $397,000 would be taxed at 39.6 percent instead of the current 35 percent, and that income from $222,300 to $397,000 would be taxed at 36 percent instead of the current 33 percent.

    For those in the top income quintile, these provisions would raise their tax liability by an average of $2,282 next year. The top 1 percent of tax filers would owe an additional $45,002.

    Allowing the Bush-era capital gains rates to rise would also affect these high-income earners.

    This year, investors pay a top marginal tax rate on their long-term capital gains of 15 percent. Under current law, this rate will jump to 20 percent in 2013, not including the additional 3.8 percent increase from the Affordable Care Act on high-income investors described earlier. In addition, a limitation on itemized deductions is also scheduled to kick in at the end of this year that could add another 1.2 percent.

    In other words, all these changes could raise the capital gains rate to effectively 25 percent on Jan. 1, from 15 percent on Dec. 31. Economists expect to see a lot of investors unloading assets that have done well — like stocks or even their own businesses — by the end of this year to take advantage of the lower tax rate.

    “There was a good reason for George Lucas to unload Lucasfilm to Disney this year,” said Len Burman, a professor of public affairs at the University of Syracuse.

    After Congress embraced the Tax Reform Act of 1986, which raised the highest capital gains tax rate to 28 percent from 20 percent, capital gains realizations almost doubled as investors scrambled to sell off investments before the higher rate kicked in. The reported gains then fell back in 1987.

    While he wants to let taxes rise for the wealthy, Obama would like to extend some provisions passed in the 2009 stimulus bill that primarily benefit lower-income families. These include expansions of the child tax credit, a tax benefit for college students, and the earned-income tax credit for larger families and married couples.

    Republicans generally want these provisions to expire. Allowing these provisions to lapse most affects households in the lowest quintile, whose taxes would rise an average of $209 next year.


    The estate tax is another sticking point, though both parties do not want the estate tax to rise as sharply as it is scheduled to under current law.

    Now, the first $5 million of a person’s estate remains untaxed, and anything above that is taxed at 35 percent. Under current law, the effective exemption would fall to $1 million and the top tax rate would rise to 55 percent.

    Estate taxes affect very few Americans; as it is, only about 0.13 percent of people who die have estates big enough to owe estate tax. If the pre-Bush-era rates go into effect as planned, that will rise to about 2 percent of estates, said Roberton Williams, a senior fellow at the Tax Policy Center.

    Obama has proposed setting the exemption for the estate tax at $3.5 million, indexed to inflation, whereas Republicans want to eliminate the tax altogether.

    “One thing you might see this year is wealthier people gifting significant amounts of their assets, putting them in trusts or giving to their heirs early,” said Williams. Still, there are limits on how much people can give away without running into gift taxes, and besides, some wealthy people might be reluctant to divvy up the fortune too soon. “You might hear some people saying, `How do I do this without losing control? Can I still keep Junior under my thumb?”’ said Williams.

    There are also a grab bag of previously extended tax provisions that affect households, businesses, charitable giving and many other issues. Neither party seems to want to let these lapse in their entirety, but again, they differ on the details.


    There are two categories of tax increases that are scheduled to kick in but are widely expected to be tamed because neither party wants them: the end of the Bush-era tax cuts for low- and middle-income families; and an expansion of the alternative minimum tax that would capture an additional 26 million taxpayers.

    Around 70 percent of tax filers would be affected by the end of the Bush-era tax cuts for those with income under about $200,000 or $250,000 for married couples. Households in the middle quintile would see their taxes rise by an average of $888, while those in the top quintile would have an average tax increase of $3,841.

    The alternative minimum tax, or AMT, sets a minimum tax rate for people earning above a certain income threshold, and was created in a slightly different form in 1969 to make sure wealthy people paid their “fair” share of taxes. Taxpayers who earn more than that minimum are supposed to calculate how much they owe under the regular system and how much the owe under the AMT, and then pay whichever is larger.

    The minimum income that sets off the AMT is not indexed to inflation, and so over the last decade Congress has repeatedly passed a temporary “patch” so that tens of millions more taxpayers are not captured by it. If Congress does not act before Dec. 31, the AMT will apply to some married couples earning as little as $45,000 and for single taxpayers earning as little as $33,750.

    At least another “patch” is considered likely, to keep the AMT from snaring millions of Americans below the median household income.

    “Congress doesn’t want that to happen, and the president doesn’t want to happen,” said Williams. “The only thing will stop them from patching it is a total logjam, which we can’t totally rule out at this point.”

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