A taxing situation

Our congressional leaders seem to have perfected the art of procrastination, or maybe they're just trying to dodge responsibility. In either case, by choosing not to deal with expiring tax cuts before the mid-term elections, they have put most Americans in a very taxing situation.

According to the non-partisan Tax Foundation, a median family of four saved $2,200 a year under the Bush tax cuts. These savings will reverse overnight on December 31 unless the cuts are extended or new tax legislation is passed.

Here is a list of tax changes that will occur automatically on January 1, 2011 if Congress doesn't act. This list comes from the October 2010 edition of the Journal of Financial Planning.

  • Personal income tax rates will rise. Here is the complete schedule:
  • The "marriage penalty" will return. This means that the standard deduction and tax brackets for married couples will be less than twice the amount for single filers--in other words, effective tax rates will go up for those couples who choose to marry.
  • Tax rates on long-term capital gains will increase from 15 percent to 20 percent with no break for those in the 0 and 15% tax brackets.
  • Tax rates on dividend income will increase from 15 percent to the taxpayer's ordinary income tax rate.
  • Itemized deductions and personal exemptions will again phase out, effectively raising the taxpayer's marginal rate.
  • The child tax credit will be cut from $1,000 to $500 per child.
  • The dependent care credit will be calculated on $2,400 of expenditures down from $3,000 for one dependent and $4,800 rather than $6,000 for two or more eligible dependents.
  • The top estate tax will increase to 55 percent on estates greater than $1 million.
  • The increased alternative minimum tax exemption will expire causing millions more taxpayers to owe AMT.
  • The ability of small business to immediately expense up to $250,000 of business equipment will be reduced to $25,000 and the 50% bonus depreciation will expire.

The politics surrounding this situation are very complex. Opponents of extension claim that extending the cuts will add over $2 trillion to the budget deficit at a time when deficits already threaten the long-term health of the economy. Those in favor of extending the cuts argue that allowing them to expire would, in effect, be "the largest tax increase in history" which, in the current economic environment, is tantamount to economic suicide. President Obama is trying to walk a middle ground by letting the Bush-era tax cuts expire for the "wealthy" while retaining them for everyone else.

How this issues shakes out in a lame duck session of Congress after the November election remains to be seen, but the risk is very high that most of us will face much higher taxes in 2011 and beyond. If you want to read an interesting analysis on the impact of the various scenarious that could unfold, I recommend an article recently published by the Tax Foundation. If you want a sense of how these scenarios might affect you personally, check out the Tax Foundation's 2011 Income Tax Calculator.