The Bush tax cuts. The Bush tax cuts primarily enacted by the 2001 and 2003 Tax Acts under President George W. Bush were extended through 2012 as part of the Tax Act of 2010. The Bush tax cuts currently set to expire at the end of 2012 include:
- reduced individual tax rates (10%, 15%, 25%, 28%, 33% and 35%);
- reduced long-term capital gain rates (maximum 15%);
- reduced qualified dividends rate (15%);
- no phase-out for personal exemptions;
- no phase-out for itemized deductions;
- expanded tax credits, including the earned income tax credit (EITC), child tax credit, adoption credit, and dependent care tax credit;
- modified education tax incentives (including Coverdell education saving accounts, the student loan interest deduction, favorable tax treatment of certain scholarships and fellowships, and an exclusion for employer-provided educational assistance).
The Bush tax cuts also gradually reduced the estate tax over 2002 to 2009, leading to its repeal in 2010. The 2010 Tax Act reinstated the estate tax for after 2010 and enacted a $5 million exemption (adjusted for inflation in 2012), a top estate tax rate of 35%, and a step-up in basis through 2012. The 2010 Tax Act also introduced the new “portability” feature allowing a deceased spouse’s unused exemption to be shifted to the surviving spouse.
Post-2012 scheduled changes. If the above provisions are allowed to expire, for tax years beginning after Dec. 31, 2012:
- individual income tax rates will rise to 15%, 28%, 31%, 36% and 39.6% (for taxable income over $250,000, adjusted for inflation);
- long-term capital gains will be taxed at a maximum rate of 20%;
- dividends will be taxed as ordinary income;
- the limit on personal exemptions will be restored such that, for higher-income taxpayers, the total amount of exemptions that can be claimed will be reduced by 2% for each $2,500 by which the taxpayer’s adjusted gross income (AGI) exceeds a certain inflation-adjusted threshold;
- the limit on itemized deductions will be restored such that, for higher-income taxpayers, the total amount of itemized deductions will be reduced by 3% of the amount by which the taxpayer’s AGI exceeds a certain inflation-adjusted threshold; and,
- the education incentives will disappear altogether or be significantly cut back.
Additionally, after 2012, the estate tax exemption is scheduled to fall to $1 million and the top rate will revert to 55%.
AMT. For 2012, absent another patch, the AMT exemption amounts are $45,000 for married individuals and $33,750 for unmarried individuals, and most nonrefundable credits won’t be allowed against the AMT. A Congressional Research Service report estimates that, unless Congress acts, 30 million plus taxpayers, or roughly one-fifth of all taxpayers, could be hit by the AMT in 2012.
Payroll tax cut. The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers—one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax).
To help stimulate the economy by increasing workers’ take-home pay, the 2010 Tax Relief Act reduced by two percentage points the employee OASDI tax rate under the FICA (from 6.2% to 4.2%) and the OASDI tax rate under the SECA tax for the self-employed (from 12.4% to 10.4%) on the first $106,800 of wages. The temporary reduction was originally scheduled to expire at the end of 2011.
Current law. The 2-point reduction was ultimately extended through 2012. For the first $110,100 of remuneration received during 2012, the 4.2% and 10.4% rates apply. Absent Congressional action, the OASDI rates will revert to normal levels after 2012.
Obamacare investment tax. A Medicare contribution tax will be imposed after 2012 on the net investment income—generally interest, dividends, annuities, royalties, rents, and capital gains—of individuals meeting an income threshold. The tax will be 3.8% of the lesser of (a) net investment income or (b) the excess of modified adjusted gross income over $250,000 for joint return filers and surviving spouses, $125,000 for separate return filers, and $200,000 for other taxpayers. This special tax on investment income will only apply to taxpayers with adjusted gross income in excess of $250,000, taxpayers who also face the reinstated 39.6% top federal income tax bracket.
California Changes. California voters approved Proposition 30 and Proposition 39. Proposition 30 increases personal income tax rates for high-income earners by creating three new tax brackets. These brackets are effective for taxable years beginning on or after January 1, 2012, and before January 1, 2019.
Taxpayers, except heads of households and married filing jointly taxpayers, are subject to personal income tax:
- at a rate of 10.3% for the portion of taxable income over $250,000, but not over $300,000;
- at a rate of 11.3% for the portion of taxable income over $300,000, but not over $500,000; and,
- at a rate of 12.3% for the portion of taxable income over $500,000.
The above thresholds for married filing jointly taxpayers are double those for single taxpayers.
Proposition 39 requires the use of single-factor apportionment for most businesses for taxable years beginning on or after January 1, 2013. An apportioning trade or business must apportion business income to California by multiplying the business income by the sales factor, unless the taxpayer is primarily engaged in agriculture, mining or drilling or banking businesses. The property and payroll factors will now only apply to those industries. The new rule is intended to have the effect of taxing a higher percentage of the net income of out-of-state businesses.
A lot can still happen on the federal side. Congress may reach an agreement to extend some of the Bush tax cuts before the end of the year or even in the new year as part of an overall budget reconciliation. In addition, an AMT “patch” is somewhat more likely to occur.
Michael Shaff, Of Counsel with Stubbs Alderton & Markiles, LLP discusses the Bush tax cuts and the post-2012 scheduled changes. Michael specializes in all aspects of federal and state taxation, including mergers and acquisitions, executive compensation, corporate, limited liability company and partnership taxation, tax controversies and real estate investment trusts.