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10 Expiring Tax Cuts to Watch For

December 6, 2010 · 9 comments

The expiring Bush tax cuts – and what will happen to them – are all over the place these days. Folks seem to have very definite opinions about what should (and shouldn’t) happen. But it also seems like, for all of the publicity over the cuts, taxpayers really don’t understand what it all means. I wasn’t surprised, then, to receive an email the other day from a reader who was confused about what the cuts actually meant for the average taxpayer; it followed nicely on the heels of a TurboTax survey that claims that 65% of taxpayers don’t understand how the cuts will affect their taxes.

With all of this in mind, I wanted to do a summary of how we got here, as well as what it all means for taxpayers.

First, the history. The Bush tax cuts aren’t one set of cuts (which is how they are often painted). They’re really a series of tax breaks which were enacted in 2001 and 2003. At the time, the plan was to eventually make them permanent but that never happened.

The centerpiece of those cuts was the Economic Growth and Tax Relief Reconciliation Act of 2001, commonly called EGTRRA. EGTRRA 2001 was written in such a way that the law basically “disappears” in 2011 and the old law kicks back in, meaning we’re back to pre-EGTRRA rules and rates.

When the economy didn’t pick up quite as fast as President Bush hoped (the point of EGTRRA), a second law was passed. The Jobs and Growth Tax Relief Reconciliation Act of 2003 is sometimes called JGTRRA (which is just silly) or EGTRRA 2003 (which, from an anagram perspective, makes no sense but is easier to remember). It accelerated some of the cuts that were slated to happen under EGTRRA 2001 – the law didn’t change so much as everything just happened a lot more quickly.

So what kind of breaks are we talking?

1, Lower individual income tax rates. Under EGTRRA, federal income taxes for individuals were lowered. A new 10% tax bracket was created at the lower end for single taxpayers making up to $6,000 (the threshold for those married filing jointly would be $12,000). The 15% bracket’s lower threshold was indexed to the new 10% bracket. The other rates were lowered as follows:

  • Those paying at the 28% rate would pay 25%.
  • Those paying at the 31% rate would pay 28%.
  • Those paying at the 36% rate would pay 33%.
  • Those paying at the highest rate, 39.6%, would pay 35%.

What this means in terms of real dollars is that tax bills (relying on marginal rates) decreased by about 3% across the board. So, for every additional $10,000 in income, a tax bill would theoretically have gone down by $300.

Without intervention from Congress, individual income tax rates would all revert (at the marginal level) to the higher rates which means an approximate 3% boost across all brackets.

2, Lower capital gains tax rates. One of the most significant changes is an overall reduction to capital gains rates, a move meant to spur investment. Under EGTRRA 2001 and 2003, the capital gains tax rates had been capped at 15% for long term gains with a remarkable 0% available for some taxpayers (those in the lowest tax brackets).

Without interventions, rates will climb back to between 10% and 20% for long term gains and 15% to 39.6% for short term gains.

3, Lower rates for qualified dividends. Under EGTRRA, taxes on “qualified dividends” were reduced to as little as 10%.

Without intervention, those rates will revert to ordinary income tax rates.

4, Higher caps for Section 179 expenses. Section 179 expenses were increased in an effort to encourage small business spending. The rates were expected to drop to a low $25,000 next year without intervention. It’s worth noting that Congress actually did address this issue this year and for 2011 – the rate was boosted to $500,000.

Without intervention, the section 179 expense cap will be lowered to $25,000 in 2012.

5, Increased standard deductions. EGTRRA lowered the taxes on many married couples filing jointly by increasing the standard deduction for joint filers. This was to address the so-called marriage penalty.

Without intervention, married couples could pay more because the standard deduction will be lower for a married couple than for two single people.

6, Decreased Child Tax Credit. The child tax credit was increased to $1,000 per eligible child.

Without intervention, the child tax credit reverts to $500; further, none of the child tax credit will be refundable for taxpayers earning less than $12,550.

7, Reduction of phase out limits on itemized deductions and personal exemptions for higher income taxpayers. Generally, the amount that high income taxpayers could itemize is phased out. However, for 2010, those limits were repealed.

Without intervention, the Pease (itemized deductions) phase outs and the PEP (personal exemptions) phase outs will be reintroduced for high income taxpayers.

8, “Repeal” of the federal estate tax. Under EGTRRA 2001 and 2003, the personal exemption for federal estate tax purposes was increased over a number of years to a maximum exemption of $3.5 million in 2009. In 2010, there was no federal estate tax.

Without intervention, the federal estate tax will reappear in 2011 with a personal exemption of $1 million and a top rate of 55% (though an additional 5% surtax applies to estates over $10 million).

9, Expiration of the Making Work Pay Credit. >The Making Work Pay Credit of 2009 was President Obama’s attempt at providing tax relief to middle class families. The credit was only in place for two tax years (2009 and 2010) and allowed taxpayers to claim up to $400 for individual taxpayers and $800 for married taxpayers filing jointly in the form of a refundable credit.

Without intervention, the credit will expire.

10, More families eligible for the Earned Income Tax Credit. EGTRRA 2001 raised the income level at which the always controversial EITC begins to phase out for couples (preventing an awkward “marriage penalty” applicable to the credit); ARRA indexed that amount to inflation.

Without intervention, the phase out amount will drop, making more families ineligible for the credit.

__________

Other tax breaks are also set to expire, such as American Opportunity Tax Credit and Federal Home Energy Tax Credits. Also affected by the sunset are AMT provisions, adoption credits and alternative energy vehicle credits.

Don’t be fooled. This vote isn’t *just about* tax rates at the high end. No matter which side you come down on (extend or expire), there are a lot of credits, deductions and special tax provisions at stake.

Make no mistake: Cuts will be expensive. Breaks will affect taxpayers.

At the end of the day, however, the analysis should be about the entire picture and not about cherry-picking the ones that make for good headlines. This week, expect more conversations about these issues. They won’t simply go away.

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{ 5 comments… read them below or add one }

1 R.G. December 6, 2010 at 1:27 pm

I wonder how all of this goes with the karma argument at http://online.wsj.com/article/SB10001424052748703673604575550243700895762.html. Once we as a country have these tax cuts, taking them away seems harsh. In fact, taking them away seems like it might be more immoral to giving them in the first place. This WSJ article has been on my mind lately.

2 Mary Kay Foss CPA December 6, 2010 at 2:18 pm

The estate tax is supposed to revert to the 2001 situation. That means a $1 million exemption and the highest marginal rate is 55%. There is no flat rate.

3 Kelly December 6, 2010 at 2:50 pm

Thanks Mary Kay for catching my typo. I also added the bit about the surtax on the super-rich which somehow got deleted from my initial post. That’s what I get for posting when I’m sick!

4 Chris Bolts Sr December 7, 2010 at 1:00 am

I just found this website doing a search on the net while researching a topic for a friend. I saw it linked to on the TaxProf’s blog, but never bothered to click. I just wanted to say that I find your blog a lot easier to read than the TaxProf’s, seeing as how I’m not a lawyer and all and it will be a welcome complement to the Prof’s website. I also liked the info on the states.

Now on to the topic: as far as the estate tax is concerned, part of the deal is that the estate tax will come back for 2011, but it will be at a 35% rate with a $5 million exemption.

5 Kelly December 7, 2010 at 5:51 pm

Thanks! I am a big fan of Prof Caron’s site but you’re right, it’s definitely more academic than my site. I’m glad that you found me!

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