I’ll admit that I didn’t see yesterday’s tax deal coming. I was fairly certain that the drama would play out through this week. We still have drama but now it’s more of the “let me explain” variety.
Let me see if I can sort out for you what happened and why.
First, let’s talk timing. Almost across the board, the extensions are for two years. That wasn’t a random number. It directly coincides with the next important set of elections: at least 1/3 of Senate seats are up for grabs, about 1/5 of gubernatorial seats will be at issue and, of course, it’s the next presidential election. So very, very calculated.
Second, let’s talk politics. This was a big win for the GOP. Huge. President Obama structured the deal, it appears, solely to gain unemployment benefits for yet another year (actually, the benefits are extended for 13 months). This was a fairly significant priority for the Democrats but politically, not very smart. Benefits have been extended seven times since 2008. Yes, folks are unemployed. While I am extremely sympathetic to the plight of those who are without jobs, I don’t think that unemployment benefits are an appropriate bargaining chip in a comprehensive tax strategy. Making the whole thing even worse? The GOP is making noise this morning (now that they know how much power they have over this Congress) about not approving the unemployment benefits after all. Yeah.
Third, the cost. The cost of extending the cuts was enormous to begin with. The Treasury set the cost of simply extending the cuts at $3.7 trillion over 10 years. That would make a two year cut would be $740 billion. But the deal goes beyond that. You have to figure in the federal estate tax provisions (see below), the payroll tax holiday (also see below) and more. I feel like an informercial spokesperson but… we’re not done yet! Now throw in the unemployment benefits extension. Yep, we’re at billions. The Dems look foolish as they were unable to stop piling on the tax breaks – it’s all very Oprah again, isn’t it? You get a tax break! And you get a tax break! Especially at the top. And the GOP should be ashamed of themselves. They promised not to let this happen. Where is the fiscal responsibility here? There is none.
So basically, everyone gets something in this deal with those at the top and those at the bottom getting the most benefit (of course). It will cost us billions. Initial estimates are at – hold onto your hats – $900 billion. And we’ll be back in the same darn boat in two years. This is supposed to be progress?
Enough with my ranting (ok, spoiler alert, there’s more below). Here’s a synopsis of the various components of the deal:
- Federal Estate Tax. I didn’t see this one coming at all. I predicted a freeze to the 2009 rates ($3.5 million personal exemption and 45% top tax rate). But apparently, it’s 1931 all over again. That’s because the rates will top out at 35% – the lowest since 1931 – with a whopping personal exemption of $5 million per person. It’s effectively a repeal for most Americans since, with a little bit of decent estate planning, a married couple can pass $10 million to their heirs without being subject to the tax.
- Individual Income Tax Rates. They aren’t going anywhere for the next two years. The same rates created under EGTRRA will stand. In other words, the effective marginal tax rates for 2010 are the same ones you’ll see in 2011 and 2012. Rest better. You’ve all avoided a 3% hike – for a family making $50,000, that means you’ve avoided a $1,500 bump in tax for 2011.
- Alternative Minimum Tax (AMT). We got our patch. I haven’t seen the numbers but I’ve been told that it’s similar to the 2009 numbers for 2010 and 2011. No word on 2012 and beyond. Congress estimates that a mere 23 million taxpayers will be affected by the AMT in 2010 instead of the projected 44 million taxpayers. I guess you can call it progress. But would it be too much to ask that we get some real relief? Some day?
- Capital Gains Rates. This was the sacred cow for much of the GOP tax strategy. Lower capital gains always, always means heightened investments and a better economy. Always. It’s worked so far, right? Cause we have the same rates for the next two years (meaning a top rate for long-term gains of 15%).
- Dividends. Same story as on capital gains rates: current rates are extended.
- Payroll Tax “Holiday.” With the administrative nightmare that was the Making Work Pay Credit gone, we needed a little something else to challenge preparers and the IRS. Enter the payroll tax “holiday.” It’s a one year (just one, not two like much of the other provisions) cut in Social Security taxes for workers. For 2011, you’ll pay in 4.2% on the first $106,800 of wages rather than 6.2%. That means a 2% cut so that a worker earning $50,000 would pay $1,000 less in 2011. But only for 2011. Good luck employers, preparers and the IRS in figuring that one out.
- Child Tax Credit. I’ll be honest. I expected to see this one go, too. The child tax credit is a darling of the Dems but always a thorn in the GOP’s side. You know, the whole stereotype of mothers having kids just to get tax benefits (as a mom, I roll my eyes at this idea but there you have it) has always been a reason to limit credits attached to children; of course, there’s also the more rational, understandable concern that having children should be a tax neutral event (this, I get). The child tax credit had been bumped under Bush to $1,000 per child with a $3,000 earned income floor to make it refundable. That will stand for the next two years.
- Earned Income Tax Credit (EITC). Show of hands: who expected this to be extended? The EITC is probably the most controversial of the tax credits. The tweaks under EGTRRA expanded the base of low to middle class families eligible for the credit, which cost taxpayers $42.9 billion in 2008. I assumed that the GOP would shrink this one back to its pre-2001 levels and allow the eligibility cap to increase. That didn’t happen. The EITC base remains the same as for 2010.
- American Opportunity Tax Credit (AOTC). Yawn. We heard all about how great this extension was from Obama, who pushed hard for the renewal. It’s a gimme. The modified version of the Hope Credit allowed a slightly bigger credit ($2500 versus $1800) for students pursuing a degree. And who’s going to vote no on tax credits for college students?
- State and Local Sales Tax Deduction. The option to deduct sales and local sales taxes on your federal income tax return – even if you don’t itemize – ended in 2009. Rumor has it that the new tax deal brings the deduction option back, retroactively, so that it will apply to 2010 and 2011.
- Transfers of IRAs to Charities. Also rumored to be in the plan? The option to allow those taxpayers over the age of 70-1/2 to roll their IRAs directly to charity. If true (and I have it on decent authority that it is), that would also be retroactive.
So that’s the summary of what’s in the tax deal (allegedly – remember, the ink isn’t dry yet). So what’s missing?
- Elimination of the Home Mortgage Interest Deduction. Realistically, I didn’t expect this to be tinkered with this year but there was a lot of noise made about it last week. It’s still there, big as always.
- Making Work Pay Credit. It’s gone for 2011 which is probably a welcome sight for many tax preparers (that Schedule M was a bear). There was some initial confusion on this one with rumors that it had been included in the deal. That turned out to be wrong. It was “replaced” with the Payroll Tax Holiday (see above).
- Lower Medical Expense Floors. There was some talk about a lower floor for medical expenses following the passage of the health care plan. Come tax talk time, nary a peep. So it stays at 7.5%.
Whew. That’s quite the summary. And it could all change in an hour. But this is what the plan is as of this morning. There’s a lot of criticism over the package – expect something to change. I just don’t know what that something will be. Any guesses?Want more taxgirl goodness? Pick your poison: You can receive posts by email, follow me on twitter (@taxgirl) hang out with me on Facebook and check out my YouTube channel.