Salt Lake City Accountants
President Obama campaigned on a promise to extend the Bush-era tax cuts for lower and moderate income individuals, but to allow them to expire for higher-income individuals. The President is not expected to change his position after the election, but there could be some compromises on the income thresholds that trigger the higher rates.
Income Tax Rates
If Congress approves the President’s proposal, the individual income tax rates would be: 10, 15, 25, 28, 33, 36, and 39.6 percent for 2013 and subsequent years. Alternatively, Congress could extend all of the Bush-era tax rates through 2013 or, in a deadlock, take no action and allow the Bush-era tax rates to sunset. Full sunset for lower and middle-income taxpayers—which would reinstate a 15, 28, 31, 36 and 39.6 percent bracket structure—is highly unlikely from a political and economic standpoint.
Under President Obama’s proposal, the 36 and 39.6-percent rates would start at a higher-income bracket level of $200,000 for single filers, $250,000 for joint filers, $225,000 for head-of-households, and $125,000 for married taxpayers filing separately. Since these thresholds were initially proposed in 2009, they would also be indexed for inflation. Also they would be keyed to adjusted gross income (AGI) rather than taxable income. Indexed 2013 projections for those AGI levels, based on the Administration’s FY 2013 Budget, are $213,200 / $266,500 / $239,850 / and $133,250, respectively.
For a married couple filing a joint return, the tax brackets under President Obama’s plan would be:
Tax Rate 2013 Taxable Income
* Also assumes continuation of marriage penalty relief
For a single individual, the tax rates under President Obama’s plan would be:
Tax Rate 2013 Taxable Income
As part of the automatic sunset of Bush-era tax benefits, after 2012 higher-income taxpayers also would once again be subject to the Personal Exemption Phaseout (PEP) and the Pease Limitation on itemized deductions (named for the member of Congress who sponsored the legislation). Alternatively, President Obama has proposed replacement of the PEP and Pease Limitation with a limit on the value of itemized deductions for higher-income taxpayers. The President would limit the value of otherwise allowable deductions to 28 percent of AGI for those in his proposed 36 and 39.6 percent tax brackets.
During the campaign, the President said he saw no way to accommodate Governor Mitt Romney’s plan to reduce the individual income tax rates by 20 percent across the board in exchange for a reduction in the number of deductions and loopholes currently available. Obama maintained that he would not support a proposal in which “the numbers don’t add up.”
The IRS has delayed issuing some 2013 inflation adjustments, including those affecting tax rate brackets, pending action by Congress. The IRS is expected to move quickly to release these inflation adjusted amounts as soon as legislation is passed by Congress and signed by the President.
President Obama campaigned on allowing the Bush-era tax cuts—including the reduced capital gains and dividend tax rates—to expire for higher income individuals, and he is not expected to change his position now. Under the President’s proposal, the current zero and 15 percent capital gains and dividend tax rates would be extended after 2012 for single individuals with incomes below $200,000 and families with incomes below $250,000.
The President’s proposal would increase the tax rate on qualified capital gains to 20 percent for single individuals with incomes over $200,000 and married taxpayers filing a joint return with incomes over $250,000. Regarding dividends, single individuals with incomes over $200,000 and families with incomes over $250,000 would pay tax on their dividends as ordinary income.
For dividends, the increase in tax rate for higher-income taxpayers represents almost a 300 percent increase when a top 39.6 percent rate is combined with the new 3.8 percent Medicare contributions tax on net investment income (NII). Combined with a jump in the capital gains rate from 15 percent to 20 percent (23.8 percent with the NII tax), some economists are predicting a massive market sell-off at year end as taxpayers engage in basis-resetting strategies and reallocation of portfolio assets. To create a softer landing, one proposal would raise rates for taxpayers only with incomes above $1 million, at least for the 2013 period until a more permanent structure under the umbrella of tax reform could be enacted.
Under current law, taxpayers in the 10 and 15 percent income tax brackets pay zero percent tax on qualified capital gains and dividends.
Alternative Minimum Tax
If the alternative minimum tax (AMT) exemption amounts are not patched for 2012, they would be dramatically less than the exemption amounts for 2011. Under current law, the AMT exemption amounts for 2012 are $33,750 for single individuals, $45,000 for married couples filing joint returns and surviving spouses, and $22,500 for married couples filing separate returns. In comparison, the AMT exemption amounts for 2011 were $48,450 for single individuals, $74,450 for married couples filing joint returns and surviving spouses, and $37,225 for married couples filing separate returns.
In early 2012, President Obama proposed replacing at least a portion of the AMT with the so-called “Buffett Rule,” essentially the principle that millionaire taxpayers should not pay a smaller effective rate of income tax than middle-class families. Although the Senate voted on a version of the Buffett Rule, the proposal was never taken up by the House.
In announcing the Buffett Rule, President Obama asked Congress to pass measures that ensure individuals making over $1 million a year pay a minimum effective tax rate of at least 30 percent. The Senate approved the legislation that would subject taxpayers earning over $2 million to a 30 percent minimum federal tax rate. The tax would be phased in for individuals with incomes between $1 million and $2 million, with those taxpayers paying a portion of the extra tax required to get them to a 30 percent effective tax rate.
The need for an AMT patch retroactive to the start of 2012 may force the lame-duck Congress to consider at least a small tax bill before 2013 in order to give the IRS time to finalize 2012 tax forms and start the 2013 tax return season on time.
Proposals for replacing or repealing the AMT appear to be made as long-term solutions. The AMT brings in a considerable amount of revenue and cannot be easily replaced. A tax on millionaires may not bridge that revenue gap. A solution that is rolled up into the umbrella of overall tax reform appears to be one focal point for tax policy now being pursued.
Child Tax Credit
After 2012, the $1,000 child tax credit is scheduled to revert to $500 per qualifying child. President Obama campaigned on the promise to make permanent the $1,000 child tax credit and is expected to support legislation that will do so.
Taxpayers who cannot take full advantage of the child tax credit because the credit is more than the taxes they owe may receive a payment for some or all of the credit not used to offset their taxes. The 2010 Tax Relief Act reduced the minimum earned income amount used to calculate the additional child tax credit to $3,000. President Obama has proposed to make permanent the $3,000 threshold.