In the curious ways of Washington, the biggest action comes from
Politicians have spent years telling you that they will never
raisetaxes . What they don't admit is that your taxes can rise
anyway, simply by letting current tax laws expire. And rise they
will. Though the "Bush-era" tax cuts were given a two-year
extension at the end of 2010, it's overwhelmingly likely that many
of these decade-long tax breaks will expire at the end of the
current quarter -- no matter who is elected in November.
That dawning reality has tax advisers scrambling, suggesting key
moves now to protect gains from the tax hikes to come.
Let's take a closer look at eight key tax breaks, and assess the
likelihood that they will soon evaporate.
1. Capital gains
In 1921, the government passed the "Revenue Act" which
provided for lower tax rates (12.5%) than ordinary income tax
rates for assets held for at least two years. Lawmakers have
vacillated ever since, at times pushing thetax rate on
investors' profits up to income tax rates, and then pushing
them lower. In fact, a key component of tax reform under
Ronald Reagan in 1986 pushed thecapital gains tax rate from
20% to 28%. Yet when George W. Bush took office, lawmakers
pushed through the "Economic Growth andTax Relief
Reconciliation Act of 2001," which lowered capital gains tax
rates to just 15%. More than a decade later, this investor
treat is likely coming to an end. Lawmakers are expected to
come up with a new rate --somewhere between the current
capital gains rate and the current income tax rates.
Estimates of a 20% or 25% tax rate are being discussed, and
we'll get a clearer sense of the actual number when lawmakers
re-visit the topic in either the "lame-duck" session of
Congress, or soon after the next presidential inauguration.
Payroll tax relief
Every American saw their payroll tax rates fall from 6.2% to
4.2% in 2009 as a way to help out beleaguered consumers.
Although both parties stress a continued commitment to middle
class tax relief, an extension of this particular measure
actually has little support. As noted, lawmakers appear set
to simply look the other way when the payroll tax cut expires
at year end. That will help boost government revenue by an
estimated $115 billion every year, though the typical worker
will take home roughly $1,000 less in 2012, according to the
Tax Policy Center.
Child tax credits
Higher payroll taxes are likely to coincide with a reduction
in the $1,000 perchild tax credit , perhaps to $500. For a
family of five, we're talking about $1,500 in more taxes,
which could have a chilling effect on retail spending. This
is a tax that will be deeply felt by middle-income families,
as families earning more than $130,000 were ineligible for
the tax credit anyway.
4. TheMedicare surcharge tax
Even as middle-income tax payers will feel the pain,
higher-income taxpayers won't be spared. In the first
presidential debate, Mitt Romney conceded that the wealthiest
Americans are likely to take a hit under his
yet-to-be-articulated plans. But this is one tax increase
that may not go into effect if Governor Romney gets elected.
The 3.8%income tax surcharge, aimed at taxpayers making more
than $250,000, was developed to help defray the costs of the
Affordable Health Care Act. If Mr. Romney follows through on
plans to repeal "Obamacare " if elected, then this tax is
unlikely to go into effect.
TheEarned Income Tax Credit
Just as the higher Medicare surcharge would hit high-end
taxpayers, a reduction or repeal of thistax break would be
felt by low-income taxpayers. The EITC is highly
controversial, with many voters viewing it as an essential
form of financial support in a time of deep economic
distress, while many others see it as a policy that keeps
many Americans from paying income taxes. Many that are
eligible for the EITC are among the "47%" that Mr. Romney
spoke of in those controversial secretly-recorded comments
everybody has been talking about. Though the EITC is unlikely
to be eliminated, it may be subject to a reduction, perhaps
back to levels seen before they were hiked in 2009. This
wouldmean that the average EITC-eligible family would be in
line for roughly $2,000 less in tax credits.
A range of tax breaks start to peter out once income reaches
certain thresholds, and without the breaks, many tax bills
can become quite high. In response, theAlternative Minimum
) exemption was devised to ensure that at least some income
is shielded from taxes. Though this tax break is hugely
popular and enjoys bipartisan support, it could conceivably
expire at year's end and not be renewed if legislators get
bogged down in gridlock. Yet there's no cause for alarm:
Congress would eventually come around to extending this tax
break, as they always do, and would retroactively apply it
back to the date of the lastexpiration . Still, it's just one
more item to potentially spook taxpayers -- at least
temporarily -- in coming months.
College tuition credits
An increasing number of students are facing high student loan
balances, and in a bid to support them, the tax credits
against college tuition payments were hiked in 2009 from
$1,800 a year to $2,500 a year (and eligibility was extended
from two to four years). As is the case with the AMT,
lawmakers are loath to move against this popular tax break,
though their inaction may push these breaks back to pre-2009
Under current laws, the first $5.12 million of any estate is
shielded from taxes when its owner passes away. After that,
the remaining value of the estate is taxed at 35%. If the
estate tax isn't extended, those figures would change to $1
million and 55% at the end of this year, ensnaring many
family-owned businesses that would conceivably need to be
sold off to pay the tax man. That's why both parties would
like to see this tax break extended, though both sides differ
on the size of such a break, and the tax rate on the
un-sheltered portion of the estate. The issue is already
being used by financial advisors to scare clients into bold
estate-planning moves, but we should expect an eventual
solution that delivers rates and thresholds very close to
Risks to Consider:
The risk here is inaction. Lawmakers routinely wait until the
last minute to get serious, and have always addressed major tax
issues before they impacted taxpayers. But gridlock in Washington
grows worse by the year, and these lawmakers now run the risk of
letting the tax situation get quite messy as they stand by
ideological purities. So don't simply assume that lawmakers will
avert a crisis in coming months.
Action to Take -->
It's becoming clearer that some taxes will go up, while some of
these tax breaks will be renewed. Radically altering your financial
planning efforts to offset these looming changes is unwise. You
should stick with long-term wealth-building plans -- even if higher
taxes will have a negative impact. Pursuing aggressivetax avoidance
measures can lure you into risky gambits that may be rejected by
theIRS anyway. If and when the U.S. government's finances are on
firmer footing and the U.S.economy looks healthier, we may again be
talking about fresh tax breaks. But that's an unlikely scenario in
-- David Sterman
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David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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