Bush-Era Tax Cuts: Sunsets Facing Individuals
The impact of the looming expiration of the Bush-era tax cuts on individuals has received the most attention because its effect is so great. If the Bush-era tax cuts expire as scheduled, individual income tax rates will increase across the board.
Income tax rates for individuals
Under current law, the reduced individual income tax rates created by EGTRRA, accelerated by JGTRRA, and extended by the 2010 Tax Relief Act, are scheduled to sunset after 2012. Unless extended, the individual marginal tax rate percentages, currently at 10, 15, 25, 28, 33, and 35 percent, are scheduled to revert to 15, 28, 31, 36, and 39.6 percent, effective for tax years beginning after December 31, 2012.
Impact: Unless Congress acts, all taxpayers — and not just higher income individuals — will effectively experience a tax hike after 2012. The top rate will jump from the current 35 percent to 39.6 percent. The lowest 10 percent rate will be eliminated. Even those taxpayers who may remain in the 15 percent bracket will pay more by not realizing the advantage of having their first dollars of income subject to the 10 percent rate bracket. Additionally, the 2 percent employee-side payroll tax cut, as enacted under the Middle Class Tax Relief and Job Creation Act of 2012, is scheduled to expire after 2012, affecting all workers in 2013 on up to $113,700 of their earned income (the projected Social Security wage base for 2013).
Impact: By far, the costliest provisions to extend are the reduced individual tax rates. According to the Congressional Budget Office (CBO), they account for over half of the total revenue loss. And according to the Congressional Research Service (CRS), the extension of the reduced income tax rates in the 2010 Tax Relief Act for two years alone reduced federal revenues by $363.55 billion.
Although the individual tax rates are scheduled to revert to the levels in place prior to EGTRRA, the bracket amounts to which each rate is applied will continue to reflect annual inflation adjustments. However, the entire 10 percent rate bracket will be eliminated and become the lower portion of the 15 percent bracket.
Impact: The majority of U.S. businesses are pass-through entities, such as partnerships and S corporations. If the provisions expire, pass-throughs will be hit hard, since profits are passed through to their individual owners. A C corporation, with its current corporate level tax of 35 percent (which may drop if recent corporate tax reform proposals are adopted), may become more attractive if individual tax rates rise.
President Obama, in his “Blueprint for America” and other proposals, has called for making permanent the 10, 15, 25, and 28 percent rates for tax years beginning after December 31, 2012. However, the 33 and 35 percent tax rates would sunset as scheduled after 2012, and would be replaced by 36 and 39.6 percent rates starting at $200,000 for single individuals and $250,000 for joint filers. Additionally, President Obama has proposed widening the tax bracket for the 28 percent rate. The House GOP has proposed consolidating the six current individual income tax brackets into two brackets of 10 percent and 25 percent.
Impact: Individuals who anticipate the possibility of being subject to a higher income tax rate after 2012 should explore shifting the timing of income or deductible expenses. Deferring deductions into 2013 may help to offset income that would be subject to a higher tax rate. Accelerating income into 2012 likewise might lower overall tax liability. Acceleration techniques include billing earlier, selling appreciated property, avoiding installment sales that defer gain, and accelerating bonuses.
Comment: The fate of the individual tax cuts is further complicated over disputes about annual inflation adjustments. The Consumer Price Index for all Urban Consumers (CPI-U) is used to calculate annual inflation adjustments to personal income tax brackets. Some lawmakers have called for using the Chained Consumer Price Index for all Urban Consumers (C-CPI-U) instead of the CPI-U. According to the Congressional Research Service, the C-CPI-U has increased more slowly than the CPI-U, and applying the C-CPI-U to individual tax provisions would slow growth in the federal budget deficit.
Marriage penalty relief
Before EGTRRA, some married couples experienced the so-called marriage penalty. EGTRRA gradually increased the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return. The 2011 Tax Relief Act extended EGTRRA’s marriage penalty relief through 2012.
Impact: If marriage penalty relief is not extended, the deduction for married couples will be 167 percent of the deduction for single individuals rather than 200 percent. Based on 2012 amounts, the standard deduction for joint filers is estimated to drop from $11,900 to $9,950 (with rounding). EGTRRA also gradually increased the size of the 15 percent income tax bracket for a married couple filing a joint return to twice the size of the corresponding rate bracket for an unmarried individual filing a single return. The 2010 Tax Relief Act extended this treatment through 2012.
Impact: Under current law, the upper limit of the 15 percent bracket for joint filers is equal to 200 percent of the upper limit for single individuals; after 2012, the upper limit of the 15 percent bracket for joint filers is scheduled to be equal to 167 percent of the upper limit for single individuals. Based on 2012 amounts, the 15 percent bracket for joint filers is estimated to end (and the pre-EGTRRA 28 percent bracket is estimated to begin) at $59,000 rather than at $70,700.
Comment: The fate of marriage penalty relief remains uncertain since it likely will be considered with more politically controversial parts of the sunsetting provisions. As a result, married couples may want to be ready to increase their withholding, or make larger estimated tax payments starting in 2013 to avoid any adverse impact from the sunset of the increased 15 percent rate bracket and standard deduction for married couples.
The “Pease” limitation on itemized deductions, which was eliminated by EGTRRA and extended by the 2010 Tax Relief Act, is scheduled to be revived after 2012. The Pease limitation, named after the member of Congress who sponsored the original provision, reduces the total amount of a higher-income taxpayer’s otherwise allowable itemized deductions by 3 percent of the amount by which the taxpayer’s adjusted gross income exceeds an applicable threshold. However, the amount of itemized deductions would not be reduced by more than 80 percent. Certain items, such as medical expenses, investment interest, and casualty, theft, or wagering losses, are excluded.
Comment: The applicable threshold for the Pease limitation, if it was in effect in 2012, would have been $173,650.
Personal exemption phase out
Higher income taxpayers may see their deduction for personal exemptions reduced or eliminated under the personal exemption phase-out rules, should the phase out be revived after 2012. The elimination of the phase out was first implemented by EGTRRA for certain years and extended by the 2010 Tax Relief Act through 2012. Under the phase out, the total amount of exemptions that may be claimed by a taxpayer is reduced by 2 percent for each $2,500, or a portion thereof (2 percent for each $1,250 for married couples filing separate returns) by which the taxpayer’s adjusted gross income exceeds the applicable threshold. The 2010 Tax Relief Act repealed the phase out for 2010 and 2011.
Impact: The applicable thresholds for the personal exemption phase out, had it remained in effect in 2012, would have been $173,650 for single taxpayers and $260,500 for married couples filing jointly.
Earned income credit
EGTRRA gradually increased the beginning and end points of the earned income credit (EIC) phase out, over and above annual inflation adjustments, for married couples filing a joint return. EGTRRA also simplified the definition of earned income, eliminated the rule that reduced a taxpayer’s EIC by the amount of alternative minimum tax (AMT) liability, reformed the relationship test, modified the tie-breaking rule, and gave the IRS additional authority with respect to mathematical errors. The Working Families Tax Relief Act of 2004 (WFTRA) and the American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) further enhanced the EIC. The 2010 Tax Relief Act extended the enhanced EIC through 2012.
Impact: If the enhancements to the EIC sunset after 2012, the EIC phase-out would be determined by reference to modified adjusted gross income rather than adjusted gross income. One reason EGTRRA made the switch to adjusted gross income was to reduce the number of calculations needed to compute the EIC.
Comment: Under EGTRRA, as extended by the 2010 Tax Relief Act, the EIC is not reduced by AMT liability through 2012.
The $1,000 child tax credit law is scheduled to revert after 2012 to $500 per qualifying child (dependents under age 17 at the close of the year). In addition to increasing the amount of the credit, EGTRRA also:
- Modified the refundable component
- Provided that the refundable portion of the child tax credit does not constitute income
- Provided that the child tax credit is allowable against regular income tax and AMT
- Repealed the AMT offset against the additional child tax credit for families with three or more children
- Eliminated the supplemental child tax credit
These enhancements were extended through 2012 by the 2010 Tax Relief Act.
Impact: Taxpayers with qualifying dependent children should consider adjusting withheld income tax (or estimated tax payments) to account for the reduction from $1,000 to $500. Current divorce settlements in which child credits and other EGTRRA-sensitive benefits are allocated may need to be recalibrated to accommodate the lower amounts.
Impact: The child tax credit is reduced by $50 for each $1,000, or fraction thereof, of modified adjusted gross income above threshold amounts. Those thresholds are $110,000 for joint filers, $55,000 for married individuals filing separately, and $75,000 for other taxpayers. If the credit is reduced to $500 after 2012, the smaller credit will phase out more quickly. The 2009 Recovery Act lowered the refundability threshold for the child tax credit from $8,500 to $3,000 (not adjusted for inflation) for 2009 and 2010. The $3,000 threshold (not adjusted for inflation) was extended by the 2010 Tax Relief Act through 2012.
Comment: President Obama and the GOP have expressed support for extending or making permanent the $1,000 child tax credit after 2012.
Comment: The maximum amount of credit a taxpayer can receive is equal to the number of qualifying children times $1,000. If the value of the taxpayer’s child tax credit is greater than his/her actual tax liability, the taxpayer may be eligible to receive the difference as a refund. In April 2012, the House Ways and Means Committee approved a bill that would require taxpayers claiming the additional child tax credit to provide a Social Security number.
Adoption credit and assistance programs
EGTRRA increased the dollar limitation for the adoption credit and the income exclusion for employer-paid or reimbursed adoption expenses to $10,000 (indexed for inflation), both for nonspecial needs adoptions and special needs adoptions. The 2010 Tax Relief Act extended the enhancements to the adoption credit under EGTRRA through 2012. In addition, the Patient Protection and Affordable Care Act (PPACA) made the adoption credit refundable for 2010 and 2011.
Comment: The adoption credit phases out for taxpayers above specified inflation-adjusted levels of modified adjusted gross income. For 2012, the phase-out level starts at $189,710.
Child and dependent care credit
The child and dependent care credit is intended to help individuals pay child and dependent care expenses so the taxpayer (and spouse if filing jointly) can work or look for work. A child, for purposes of this tax benefit, must be under 13 years of age at the close of the tax year. A qualifying dependent who is disabled, however, may be of any age if he or she is a dependent, or spouse, who lives with the taxpayer for more than half the year. EGTRRA and subsequent legislation increased the maximum amount of eligible employment-related expenses for purposes of the dependent care credit, and made other enhancements. The 2010 Tax Relief Act extended these enhancements through 2012.
Comment: Expenses qualifying for the child and dependent care credit must be reduced by the amount of any dependent care benefits provided by the taxpayer’s employer that are excluded from the taxpayer’s gross income. Total expenses qualifying for the dependent credit are capped at $3,000 in cases of one qualifying individual, or at $6,000 in cases of two or more qualifying individuals subject to income thresholds. Absent extension, these monetary amounts are scheduled to be reduced to $2,400 in cases of one qualifying individual, or $4,800 in cases of two or more qualifying individuals subject to income thresholds. The current 35 percent credit rate is scheduled to fall to 30 percent after 2012.
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