Now that everyone is talking about the fiscal cliff that looms as the new year approaches, some are asking what sort of changes will appear on the tax landscape.
For those who can barely recall what happened yesterday, trying to remember what the federal tax law looked like more than a decade ago is impossible. We all have become accustomed to the lower tax rates and so-called “loopholes” that were created under the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003, more commonly known as the Bush tax cuts, that it is difficult to imagine that tax rates could actually have been higher in the past 12 years.
So let’s take a look at what could happen if Congress does nothing between now and when the bells ring in 2013. Much of the following could change as a result of Congressional action in the next few weeks. The change that would affect all taxpayers is that income tax rates would rise. Currently the bottom rate is set at 10 percent rising to a maximum income tax rate of 35 percent. Come Jan. 1, the bottom rate would revert to 15 percent while the top rate on the wealthiest taxpayers would rise to 39.6 percent.
Taxpayers who are currently paying a 25 percent rate would see that rate revert to 28 percent while those who currently pay 29 percent would see their income taxed at 31 percent and those currently paying a 33 percent rate would see their tax rate rise to 36 percent. On one side, there are those who would like to retain the current rate structure while others, including the president, would like to see the top two brackets return to their pre-Bush levels of 35 percent and 39.6 percent. These two tax rates would apply to individuals making $200,000 and for couples making $250,000. Politically, no side wants to offend the so called middle-class.
Another provision would resurrect the 20 percent tax rate on long-term capital gains up from the current 15 percent, and for high-income individuals a tax of 3.8 percent would also be imposed, making the overall maximum tax rate on capital gains 23.8 percent. This latter surcharge, if you will, is a result of the Patient Protection and Affordable Care Act otherwise known as Obamacare. The president’s position on this issue is to retain the current 15 percent for individuals making $200,000 and for couples making $250,000. Again, no one wants to disturb the hornet’s nest of “middle-income” families.
Meanwhile dividend income, which has also enjoyed a 15 percent preferential rate for the last 10 years, will see the return to ordinary income tax rates. Like long-term capital gains, dividend income will also be subject to the 3.8 percent tax rate for Obamacare applying to high-income individuals resulting in an overall tax rate on qualified dividends rising from the current 15 percent rate to as much as 43.4 percent. Again, the president’s proposals would retain the lower 15 percent for dividend income for those under the $200,000 or $250,000 threshold.
The phase-out of the personal exemption and the limitation on itemized deductions would be reinstated for certain high-income taxpayers. President Obama recommends the threshold be set at $200,000 for individuals and $250,000 for couples. The limitation on the itemized deductions had been phased out at the end of 2009 and for the three-year period from 2010 to the end of 2012, there was no limit.
The “marriage penalty” that had been repealed for the last 10 years will be reinstated. Between the year 2003 and the end of this year, joint filers were allowed a standard deduction equal to twice the amount allowed a single taxpayer. Beginning in 2013, the standard deduction for couples will drop back to 167 percent of the deduction allowed single taxpayers.
The refundable tax credit for child care will drop from its current $1,000 to $500 and will no longer be a refundable tax credit so taxpayers will not get a refund check should the amount of the credit exceed the taxpayer’s liability.
Finally, the biggest unknown will be the federal estate tax or “death tax.” Should nothing be done by Congress, the estate tax exclusion will drop from the current $5 million to the pre-Bush level of $1 million and rates could go back to a high of 55 percent from the current maximum tax rate of 35 percent. While many doubt it will revert to the previous levels, that again will depend on whether Congress can reach a compromise.
Lowell L. Kalapa is the president of the Tax Foundation of Hawaii.