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Sirote Legal Alert: The Changing Tax Climate

December 10, 2012

The 2010 Tax Relief Act extended the “Bush tax rate" cuts through 2012. Although President Obama recently proposed additional tax changes for 2013, without further legislation, the tax rates revert to previous levels in 2013. Without some agreement in Congress, here is what we anticipate:

What Did the 2010 Tax Relief Act Do?
Because most of the looming changes relate to the expiration of the 2010 Tax Relief Act, it is worth noting what the legislation accomplished. The Act extended through Dec. 31, 2012, the individual marginal income tax rates of 10, 15, 28, 33 and 35 percent. The 2010 Tax Relief Act also maintained the reduced maximum capital gains rate of 15 percent on adjusted net capital gain of non-corporate taxpayers (for regular tax and AMT purposes), and the zero percent capital gains rate on adjusted net capital gain of non-corporate taxpayers in the 10-percent or 15-percent income tax bracket. Similarly, the favorable taxation of “qualified” dividends received by individuals, trusts or estates at capital gain rates was extended through 2012.

What Will Happen Without Further Legislation?
In short, the 2010 Tax Relief Act provisions will expire. First, marginal income tax rates, capital gains rates and dividend rates will go up.

  • The individual income tax rates will revert to 15, 25, 28, 36 and 39.6 percent.
  • The maximum capital gains rate (generally applicable to long-term capital gain property) will increase to 20%.
  • Dividends will be taxed at the new ordinary income rates (which are described above).

Next, the Medicare contribution tax will take a bite out of your income. Beginning in 2013, the 3.8% Medicare contribution tax on “net investment income” in excess of $200,000 ($250,000 for joint filers and $125,000 for married filing separately) will apply. Also 0.9% additional Medicare tax on earned income in excess of $200,000 ($250,000 for joint filers and $125,000 for married filing separately) will apply.

Net investment income includes interest, dividends, annuities, rents and royalties plus long term capital gains and anything else classified as income from a passive activity. Thus, without some action on the part of Congress, the top marginal tax rate applicable to dividend income will increase from 15 percent to 43.4 percent (39.6 + 3.8). This dramatic change demonstrates the need for proper planning and monitoring of the situation.

The Current Presidential Proposal – a Limited Amount of Relief Might be Available.

President Obama has proposed a deficit reduction plan which Congress is considering. The proposal has not gained much traction in Congress, with Republicans adamant that the proposal does not go far enough in providing tax relief. The main sticking point in Congress appears to be what income levels will receive tax relief. However, because the Presidential proposal is likely to serve as the basis of future discussions, it is worth summarizing.

The proposed plan seeks to generate $1.57 trillion in new tax revenue. The income will be generated by a combination of income tax rate hikes, elimination of deductions and incentives and estate tax changes. Briefly, the proposal provides for the following:

  • Allowing the “Bush tax cuts" to expire for higher income taxpayers
  • Elimination of the capital gain preference
  • Restoring the estate tax to 2009 levels
  • Limiting itemized deductions on higher income taxpayers
  • Eliminating special depreciation deductions for corporate aircraft, eliminating oil, coal and gas tax incentives, repealing LIFO and various other tax incentives.

The most significant and controversial part of the proposal is the elimination of the Bush tax cuts, which will cause individual income tax rates to revert to 15, 25, 28, 36 and 39.6 percent. Capital gains and qualified dividends will be taxed at 20% for single taxpayers with income over $200,000 ($250,000 for married filing jointly). Moreover, the 3.8% and 0.9% additional Medicare taxes would apply as set forth above.

The proposal also reduces the tax benefit of itemized deductions and other tax preferences to 28%. The provision would apply to single taxpayers with income over $200,000 ($250,000 for married filing jointly).

Click here for a summary of these changes.

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