11 Dec Taxmaggedon – The Fiscal Cliff
The media has begun calling Congress’s inability to address the expiring Bush-era tax cuts and automatic budget cuts planned during the last debt ceiling debate “Taxmaggedon” or the “Fiscal Cliff.” The following is an explanation of the Bush Tax Cuts, why they’re in the spotlight, and what you need to do to prepare for the expiration of these cuts.
What Are the “Bush Tax Cuts?”
The “Bush Tax Cuts” are a combination of several acts originally signed into law during President George W. Bush’s first term. At the time, they were hailed as the biggest cuts in 20 years.; Overall, they included more than 50 tax breaks for individuals and businesses.
The political timing of these cuts was a response to the dot-com bubble burst and subsequent recession that lasted from 2001 through 2003. The tax cuts were billed as a temporary tax break meant to stimulate the economy and help individuals and businesses weather the recession. Built into the cuts were sunset provisions, meaning that they would eventually expire. However, these cuts have now been on the books for years. They were first extended/accelerated during Bush’s second term, and most recently in Obama’s first term.They’re now set to expire after 2012.
Some of the “Bush Tax Cuts” set to expire include:
- Reduced income tax rates
- Unless extended, the individual marginal tax rates—currently at 10, 15, 25, 28, 33, and 35 percent—are scheduled to revert to 15, 28, 31, 36, and 39.6 percent.
- Preferential capital gain and dividend rates
- Unless extended, the capital gains tax rates will increase from 15% to 20% and dividend tax rates will go from a maximum of 15% to 39.6%.
- Increased child tax credit
- Unless extended, the $1,000 child tax credit would be reduced to $500 per child.
- Increased dependent care credits, earned income credits, and adoption credits
- Unless extended, various other individual provisions would be reduced.
- Education tax breaks
- Unless extended:
- Coverdell Savings Accounts contributions will be reduced from $2,000 to $500.
- Student loan interest deductions will be reduced.
- American Opportunity Tax Credit will expire.
- Marriage penalty relief
- Unless extended, the deduction for married couples will be 167 percent of the deduction for single individuals rather than 200 percent, meaning it’s more beneficial to file single.
- Some credits have income phase-outs that penalize working spouses. Adjustments meant to reduce this penalty would expire.
- Phase-out and ultimate repeal of the estate tax
- Congress allowed the estate tax to phase out completely for tax year 2010, but revived it for 2011 and 2012 with an exclusion amount of $5 million and top tax rate of 35%.
- Unless extended, the exclusion amount would be reduced to $1 million and the top rate would jump to 55%
- Business-specific tax breaks
- Credits for employer-provided child care would be eliminated unless extended.
- Exclusion of gain on the sale of small business stock would be eliminated.
When the tax cuts were enacted with the sunset provisions, few members of Congress expected those sunsets to ever take place. The sunsets provided an opportunity to squeeze in more tax breaks at a lower projected cost. However, there simply is not enough money to make the cuts permanent. The Congressional Budget Office (CBO) has estimated that extending all of the cuts would cost $2.84 trillion over 10 years. Congress cannot keep punting, extending the cuts indefinitely while concurrently extending spending levels.
What Will Congress Do With The “Bush Tax Cuts?”
The sunsets are scheduled to occur at the end of this year. Yet here we are in June, 2012, with no agreement in Congress on a path going forward.
As written in Forbes, “Most politicians are reluctant to raise taxes. In this case, they may not have to because the sunset provisions embedded in tax-cutting legislation from the Bush era will result in significant tax increases in the United States over the next few years as long as they do nothing. Whether they will do this with an impending election is another thing.”
The Democrats have proposed extending the tax breaks focused on middle and lower income taxpayers but have opposed extensions for breaks benefiting higher income taxpayers, arguing there is not enough money to pay for them and the country cannot afford them with the current deficit.
The Republicans have proposed extending all of the tax cuts, but have not been very clear on how to pay for them, arguing either for spending cuts or not paying for them at all since it is just a continuation of existing tax breaks. They argue that the tax breaks will help stimulate the economy and produce jobs and business that will raise government revenues in the long term. They also argue that raising taxes as the economy is struggling to recover will harm job creation and could push us back into recession.
The different approaches to addressing the sunset have produced an increasingly likely scenario in which the sunsets occur because the sides cannot agree on how best to avoid it. Each party also seems to see political advantage in the fall elections to holding their ground and not compromising with the other side. This makes passage of legislation addressing the sunset issue look unlikely before the fall elections. Depending upon the outcome of those elections, members of Congress may be inclined to address the issue in the lame duck session of the current Congress or leave the matter to the new Congress to resolve in 2013.
How Should I Prepare?
Just as we saw Congress allow the estate tax to expire at the end of 2009 (something that most analysts never believed would happen), it seems wise to prepare for the possibility that the sunset of Bush tax cuts will occur and to start to plan accordingly. Because the expiring cuts affect multiple pieces of individual, business, and estate taxation, no one aspect of the law should be analyzed in a vacuum; all of the pieces are moving.
For example, a taxpayer could suppose that delaying charitable donations until 2013 (making the check out in January instead of December) would be the wise move because you’d be deducting the contribution against a higher tax rate. However, if another piece of the tax puzzle is allowed to sunset, high income taxpayers will have a portion of their contributions phased out. In some cases, making the donation in 2012 might be the better plan.
Simplified Tax Calculator
This simplified tax calculator developed by the Tax Foundation will help individuals get a rough idea of their tax burden under 3 default scenarios:
- Full expiration of all tax cuts
- Full extension of all tax cuts
- Pres. Obama’s plan to partially extend some cuts
Of course, this simple calculator will not provide the assurance you need to be prepared for what the media has begun calling “Taxmaggedon.” We will be adding posts in the near future addressing specific areas of the tax law, and their possible effect on you.
Better than blog or simple online calculator, the CPAs at Smith, Kunz are a wonderful resource in evaluating your specific tax situation. We can make sense of all the moving parts, and explain your options in a bottom-line, concise manner you can be confident in. Please give us a call at (208) 356-8500, and we’ll carefully analyze your specific tax situation. Then, no matter what Congress does or doesn’t do, you’ll be secure with your plan.