May 26, 2010

Fate of Bush Tax Cuts Uncertain As Expiration Approaches

by William Ahern

At the end of 2009, Congress froze up and let the estate tax expire, but if Congress is similarly paralyzed at the end of 2010, it won't be taxes that expire. It will be tax cuts. All the tax cuts enacted in 2001 and 2003 are scheduled to revert to 2001 law on January 1, 2011, because they were enacted on a 10-year temporary basis. Here is a comprehensive list of tax cuts expiring at the end of this year. Many are the so-called Bush tax cuts from his first term, but many have been enacted since, during both the Bush and Obama administrations.

The probability that Congress will just let all those tax cuts expire at the end of 2010 is small. The result would be a massive tax hike on middle-income people because the Bush tax cuts have been worth about $2,200 in tax savings each year for the median family of four.

The most likely scenario is what President Obama has outlined in his budget: that the majority of the Bush tax cuts will be kept, but the ones that benefit couples who earn over $250,000 and singles making over $200,000 will either be allowed to revert to their higher, 2001 levels, or they will be raised in some other fashion.

There are other possibilities for how the income tax code could end up at the end of 2010. Senators Wyden and Gregg have introduced a tax reform bill, and a presidential commission will report in December on some tax and spending options that could address the nation's growing indebtedness. Congress may suggest raising taxes or cutting spending even before the commission reports. And of course, there are already new taxes as part of the health care bill, quite apart from the expiring tax cuts.

Below, see a selected list of the tax increases that could occur on January 1, 2011. These are only the most well known provisions of the Bush tax cuts that, if allowed to expire, would come to the immediate attention of the nation's taxpayers.

  • The two "marriage penalty elimination" provisions will expire, so that:
    • The standard deduction for married couples will fall, no longer double what it is for single filers; and
    • The ceiling of the 15% bracket for married couples will fall, no longer double what it is for single filers
  • The 10% tax bracket will expire, reverting to 15%
  • The child tax credit will fall from $1,000 to $500
  • The tax rate on long-term capital gains earned by middle- and upper-income people would rise from 15% to 20%
  • The tax rate on qualified dividends earned by middle- and upper-income people would rise from 15% to ordinary wage tax rates
  • The 25% tax rate would rise to 28%
  • The 28% rate would rise to 31%
  • The 33% rate would rise to 36%
  • The 35% rate would rise to 39.6%
  • The PEP and Pease provisions would be restored, rescinding from high-income people the value of some exemptions and deductions
  • The estate tax would be restored with an exemption level of $1 million and rates that top out at 55%

The plan outlined in the Obama administration's budget is to allow only one of those 12 provisions to revert exactly to what it was in early 2001:

  • The top tax rate will revert from 35% to 39.6%

Five of those dozen major provisions will change, but they won't go back to exactly what they were in 2001:

  • Estate tax law will revert to 2009 instead of 2001: exemption of $3.5 million and top rate of 45%
  • Rate on long-term capital gains will revert to 2001 law (rate of 20%) but only for couples with over $250,000 in AGI the year the gain is realized ($200K threshold for singles)
  • Dividends will be taxed just like long-term capital gains
  • The 33% tax rate will revert to 2001 law (rate of 36%) but the income threshold where that bracket starts will shift up to $250,000 in taxable income (couples) and $200,000 for singles
  • The PEP and Pease provisions will be restored, rescinding from high-income people the value of some exemptions and deductions, but the income threshold where they start to pay more will shift up to $250,000 in taxable income (couples) and $200,000 for singles

The other 6 of the 12 major Bush tax cut provisions for individuals listed above will be preserved as enacted during the Bush years.

There are many other provisions that will expire, including EITC eligibility levels, education IRA provisions, and others, not to mention Obama's biggest tax cut, the making-work-pay credit, which was a one-year tax cut in 2009 that was renewed for 2010. See the complete roster.