Get Ready for Taxmageddon: Tax Increases and New Taxes Lurk on the Horizon Taxmageddon.

No, that’s not the title of the next summer blockbuster movie. That’s the media’s name for the fiscal fiasco that could ensue next year as roughly 100 tax cuts are scheduled to expire and a half-dozen new taxes are set to take effect on January 1, 2013.

If you’re thinking this sounds like a sequel to a bad movie, you’re right. We’ve been through some of this before. For starters, after a two year extension, the so-called Bush tax cuts will expire on December 31, 2012. After that, the top income tax rate will increase from 36% to 39.6%, qualified dividends will become subject to ordinary income tax rates, and the maximum tax on long-term capital gains will jump from 15% to 20%.

The recent 5-4 Supreme Court Ruling that upheld President Obama’s Affordable Care Act fits right into the Taxmageddon script. In writing the opinion for the majority, Chief Justice John Roberts pointed to the taxing-power of Congress as rationale for his vote. In fact, the Americans who choose not to buy health insurance will pay a tax for failure to have health insurance.

We are also confronting other new taxes. As part of the Health Care Reform Act of 2009, individuals earning more than $200,000 and couples earning more than $250,000 will shoulder both an additional tax increase and a new tax beginning in 2013. First, their Medicare Payroll Tax which is currently 2.9%, split between the employee and employer at 1.45 % each, will increase 0.9% on income above the thresholds. So, for example, in 2013, a single person making $260,000 will pay 1.45% on the first $200,000 in wages, and 2.35% on $60,000.

The new tax, the Medicare Contribution Tax on Unearned Income, imposes a tax of 3.8% (again, on incomes exceeding the thresholds mentioned above) on net investment income such as interest, dividends, capital gains, annuity payments, rents, and royalties. Also, income from a business that’s considered passive (real estate, for example) or a business that trades financial instruments and commodities will be subject to this new 3.8% tax on net income. Notably, distributions from Individual Retirement Accounts (IRAs) and Roth IRAs are not considered “investment income” and therefore not subject to this tax. Also, income from tax-exempt municipal bonds is not subject to this new tax.

In terms of tax planning, there isn’t anything we can do to avoid the additional Medicare tax as it is a payroll deduction with no exemptions. However, the new tax on unearned income could be reduced by allocating assets that typically generate higher returns to an IRA or other tax-deferred account. We might also re-consider the role of municipal bonds in a portfolio.

Unfortunately, that’s not the end of the tax increase story. Key provisions in the 2009 economic stimulus bill will also sunset at the end of this year, resulting in a number of changes, including reductions in the child tax credit and the American Opportunity Tax Credit for college tuition. And, if that’s not enough, the previous penalty on married couples is also waiting in the wings, set to kick in again for 2013. Further, an estimated 25 million middle-income taxpayers will be hit for the first time by the alternative minimum tax (AMT). (Ironically, the AMT was passed in 1969 to ensure that a few hundred millionaires would pay their fair share of federal taxes. The fact that the tax has never been indexed for inflation lands us where we are today.)

And now for the kicker: In the estate planning arena, the “Death Tax” reverts to 55% on January 1, 2013 with a $1 million exemption. That’s a big jump from the current 35% tax rate and $5 million exemption, so we have to wonder if Congress will act to prevent such a steep increase.

Although this is a substantial list of increases, I have cataloged only the major tax changes most likely to affect you. Of course, Congress could decide to intervene. Should we expect that the Bush tax cuts will be extended as they have been? Nobody has the answers. We can only speculate. Amazingly, although anyone who is employed will pay more taxes in 2013 unless Congress and the President reach a tax agreement, our elected representatives continue to pay little attention to the potential for Taxmageddon to occur. After all, there are elections to worry about, right?

Congress has a real knack for waiting until the last minute to deal with crucial financial issues. Remember how the Bush tax cuts were extended in the waning days of 2010? Remember last summer when our government was held hostage to fractious political debates over raising the debt ceiling? Is this how we run our personal lives? Do we wait until we are on the brink of disaster before digging our head out of the sand to make a decision?

What is abundantly clear is that our country needs real tax reform rather than a series of band-aid fixes. The longer Washington delays making long-term tax policy decisions, the tougher it will be for individuals, families and businesses to plan and the longer it will take to get our economy back on solid ground. As always, please call me if you would like to discuss your tax situation in light of these impending changes.

Leave a Reply

Your email address will not be published. Required fields are marked *