Jeff Schnepper: Biggest-ever tax hikes just ahead?

The Basics

Biggest-ever tax hikes just ahead?

The Bush tax cuts are due to expire at the year's end. But count on Congress to do something about taxes after the November election. Here's what's likely to happen.

By Jeff Schnepper
MSN Money

The stock market implosion fried your retirement nest egg, your house is now worth less than the mortgage securing it, you're holding on to your job by a slowly unraveling string, and now you're facing the biggest tax increases in the history of the U.S. Tax Code. No wonder more retirees are filing for bankruptcy.

Unless Congress acts soon, the Bush tax cuts created by the Economic Growth and Tax Reconciliation Act of 2001 will expire at the end of 2010. Here's what's at stake, what I expect to happen and how I suggest you plan for the changes:

Estate tax

A properly drafted will would have sheltered $7 million for a married couple from the Internal Revenue Service in 2009. We had an estate tax with a $3.5 million exclusion.

This year, there is no estate tax -- we have an unlimited exclusion. George Steinbrenner, the principal owner of the New York Yankees, picked the right time to die. His family saved a federal estate tax of more than $500 million.

But unless Congress acts, the estate tax will return Jan. 1 with an exclusion of only $1 million. Between a house, a retirement plan and any self-owned life insurance, the newly resurrected "death tax" will slam the upper middle class and suck bundles of dollars from their heirs.

Nobody wants an estate tax with only a $1 million exclusion. The Democrats are fighting for a $3.5 million exclusion with a top 45% rate; the Republicans demand a $5 million exclusion with a top 35% rate. They've been arguing this issue for more than two years now with no resolution.

Sen. Olympia Snowe, R-Maine, hit the nail on the head when she said: "It's all political theater. It's not about legislating anymore. It's all for the election coming very shortly."

After the November election, there should be a compromise. I expect the maximum rate to phase downward from 45% to 35%. I also predict an exclusion of $3.5 million for 2010 and 2011, phasing up to $5 million with a return to full step-up in basis. I suspect the law to be retroactive for 2010, but the estates of those dying before passage could follow the current zero-estate-tax rules.

Investment and income taxes

Here's where the issues become really dicey. Hefty increases in income taxes and marginal rates would turn normal tax planning on its head. Unless Congress acts, this is what will happen to tax brackets and capital gains:

  • The 10% bracket for low earners will disappear, and those dollars will be taxed at 15%.
    That's a 50% increase in tax on those dollars for everyone, including those least able to afford it.

  • The top marginal bracket will go from 35% to 39.6%. That's an increase of more than 13%.

  • The maximum marginal rate on long-term capital gains will go from 15% to 20%. That's an increase of 33%. The zero tax rate for those in the 15% bracket or lower will disappear.

  • The maximum rate on qualified dividends will jump from 15% to 39.6%. That's an increase of 164%.

Do you expect these increases to go into effect? Rather than accelerate deductions and defer income, you'd defer deductions until next year, when they will be worth more, and accelerate income into this year, so that it will be taxed at a lower rate.

Recognize capital gains now at a lower rate, even if you turn around and repurchase the same securities immediately. The wash-sale rules apply only to losses, not gains. From a tax perspective only, dump your dividend stock in exchange for appreciating securities. Trading dividend-yielding investments taxed at as much as 39.6% for investments producing capital gains with a top tax rate of 20% would be more than prudent, again purely on a tax basis.

Phaseouts by income

Congress is not known for its transparency. Rather than raising your taxes directly, it chooses to hide the increase by decreasing your deductions. As your income increases above certain floor levels, both your deduction for personal exemptions and the total of your itemized deductions are reduced. The expiring Bush tax cuts phased out these exemption/deduction slicers. They're scheduled to return Jan. 1.

This is nothing more than a 3% to 5% increase in your marginal tax. Again, if rates are going up and deductions going down, the new planning paradigm would be to accelerate income into 2010 rather than 2011.

Child credit

The child tax credit is now $1,000 for each dependent child under age 17.

That's a $1,000 reduction in your tax. Without congressional action, it may fall 50% to $500 for 2011.

Education savings accounts

Contributions to Coverdell Education Accounts (what used to be called Educational IRAs) are capped at $2,000 a year. If spent for appropriate educational purposes, the earnings on these accounts are tax-free. If the Bush cuts expire, the limit falls back to $500 per year.

If you invested $2,000 a year at 7% into a Coverdell Education Account for 18 years, you would have $38,758 in tax-free income and a total account valued at $74,758. At $500 a year, the tax-free income would drop to $9,690, with a total account value of $18,690.

Deductions that will be renewed -- again

This is where Congress really plays politics. That's from the Greek, "poly" meaning many and "ticks" meaning bloodsuckers.

We have a whole lot of tax provisions that are scheduled to expire but that are typically renewed each December. They include:

By waiting until the end of the year, Congress shamefully makes planning a "will they or won't they" game. It also causes costly IRS confusion and frustration. That's because it's hard to design and print tax forms for January distribution if the laws keep changing at the end of December.

Congress will renew the extenders. But, as many have pointed out, it's difficult to plan when you don't know the rules until the last month in the game, especially when those rules change each year. How can an employer make a decision to hire additional employees when the employer doesn't know what the cost will be (health reform, anybody?) or even what the tax implications will be?

If "con" is the opposite of "pro," is Congress the opposite of progress? Think about that when you go into the voting booth next week.

Published Oct. 28, 2010

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114Comments
11/08/2010 10:27 AM
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Talk all you want about tax rates. The bottom line is us employers are not going to work harder for less. So if taxes go up, I will purchase some leisure time instead of investing and taking risks and await the next Reagan. No hiring.

I hope you are doing well in your resume killing GREEN jobs.
11/08/2010 2:37 AM
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To think the Democrats really care about the folks especially the retired is a misnomer.  It was the Clinton admin. who raised the retirement age for my generation from 65 to 67 and 10 mos. in order to receive full benefits.  Also, the Clintons made social security income taxable where it was exempt before!  Now the Dems want to eliminate Soc. Security if you have enough money in your IRA!
11/08/2010 2:30 AM
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Speculating here, will Congress eliminate the mortgage interest deduction and make Social Security benefits unavailable if you have certain $ in your IRA account.
11/06/2010 11:13 PM
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Debit was created by Dems.... Hey bail everone out....
11/06/2010 2:58 AM
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I hope President Obama Veto's any tax cuts and lets the tax rates go back to when President Bill Clinton was able to balance the budget and have a surplus.  If we don't start getting the budget balanced, then inflation will take the value of the money away from all the baby boomers anyway.  What good does it do to get to keep a few dollars more if the dollar becomes worthless in the process? 
11/05/2010 8:18 PM
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Some how wealthy people managed to get rich and stay rich before these tax breaks were given to them only 9 years ago. This article is very slanted and misleading.

"All of the successful people" are not being punished. They are going to have to pay just like the rest of us schmoes who can not afford a CPA, tax attorney and accountant to help us keep our taxes low. Dollar for dollar the middle class has always been hit harder.

11/05/2010 6:01 PM
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lets penalize all the successful people in the USA - make them pay more taxes for their hard work, sacrifice and success. its Obama policy at its finest
11/05/2010 4:16 PM
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ASSOCIATE the proper TAXES:

Vehiclc gets less than 20 mpg -make a gas nozzle that ONLY fits those -ADD ROAD TAX

Got a big boat, rode one last week- 32gal an HOUR !-add Bridge and water tax.

Have 8 kids in school-riding buses-eating school lunches-playing sports-TAX each kid -NOT A CREDIT!

Kids TOO FAT- NO FREE HEALTH TAX EM!

NO taxes on RETIREMENT.  NO taxes on SS.  NO taxes on ESTATES.  NO taxes on fuel for vehicles over 30mpg.  NO taxes on NEW HIRES,PENALTIES on LAYOFFS.  

11/05/2010 4:03 PM
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Stop giving TAX BREAKS for people with MORE than 4 KIDS. They cant afford it and the Gov pays for it ALL the way thru COLLEGE. RAISE the taxes for income over 1 MILL, SEEMS now a days ,IF SOMEBODY EARNED MORE THAN A MILLION , THEY RIPPED SOMEBODY OFF!
11/05/2010 3:57 PM
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HOW about giving the TAX breaks for the PEOPLE WHO EARNED it. RAISE SS and LOWER RETIREMENT AGE. Millions of Retirees are forced to work,THEY WONT BUY NEW CARS AND HOUSES! Let them retire,STOP PAYING 30 yr olds UNEMPLOYMENT to sit on their ASSES and watch TV and play XBOX. Raise SS, FORCE retirement at 62, Hire the younger generation and LET THEM BUY CARS and HOUSES. IT WORKED for 100's of years! NOW the COUNTRY OPERATES **** BACKWARDS
11/05/2010 6:37 AM
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Richard Nixon balanced the budget during the height of the vietnam war and that's a fact.Social security and medicare are only broke because congress steals that money and uses it elsewhere.Left alone they sustain themselves.Another fact.There is a hidden 25 percent tax on social security that doesnt even show up on your IRS records.Another fact. The VA is disfunctuntonal because the steal from their coffer and use it anywhere they please.I know;I worked there.Face it ;our government is corrupt,and they lie to us all.Fact.
11/04/2010 5:33 PM
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@ MMCI1,
You clearly have a poor understanding of where we currently are compared to Reagan. Reagan increased spending and taxes compared to Carter. Taxes are at a historical low right now and we are at a historical point of national debt. Wars are not free and represent more than half of the national debt. We are now need to start paying for Bushes mistakes as a country in the form of higher taxes. And don't use the old Obama high spending BS either. the bank bailout has stabilized the economy and returned our markets to profitability. In fact; even though the markets were in free fall when Bush left, if you invested $100k on the day Obama took office in NASDAQ average today it would be worth $177k (a 77% return). The government is expected to get every penny back as well. As for the car companies, once again the move saved millions of jobs and two of the largest US companies. The Government/tax payers are expected to make a profit when stocks go on sale next week. According to the Congressional Budget Office retaining the Bush TAX CUTS would result in a net gain of $10billion GDP for 2011; whereas letting them expire and using that tax money to help with unemployment insurance and job training for the poor would result in a net gain of $52billion GDP for 2011. As an employer would you rather have $10bill or $52bill in the economy? Besides, why are all the republicans so crazy about defending and extending tax cuts for the top 2% of the population when the Obama one time tax cut that gave singles $400 (as opposed to Bushes $300) is also scheduled to expire at the end of the year???? They must only care about the top 2%. Don't kid yourself guy.
ps: I just got a GREAT job thanks to "the Green job market", in fact here in Colorado there are thousands of new "Green" jobs. Besides, how is a job a resume killer?
11/04/2010 9:50 AM
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LET'S HERD THEM UP AND MOVE THEM OUT, THE 2TH OF NOV. IS GONE.[ YES]
11/04/2010 6:17 AM
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This employer and former job creator is doing OK but will not hire or invest. Why work harder for less.

I will wait for the next Reagan and then clean up with all the pent-up demand.

In the interim, enjoy your resume killing Green Jobs. I can't wait for you all to run Obama out of town like you did to Jimmy Carter.

I also will not buy GM or Chrysler cars.

11/02/2010 2:39 PM
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Whenever I hear or see the term "death tax", my teeth grate.  In the vein of Mike_PDX's comment, we should call the payment we send to the government when a substantial amount of cash changes hands what it is, a WINDFALL TAX.  I don't hear people complaining too much when they hit the lottery or a slot pays off big in Las Vega - they celebrate their newfound riches.  Paying taxes on a windfall is no different than a lottery payment except the recipients are limited to whomever is in the will.
11/02/2010 2:06 PM
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Why is this a "Tax HIKE"?  I don't see any of the pundits yelling all over the media that Macy's "HIKES" prices again, just because the sale is over!.
Perhaps since the country is in dire financial shape we should return to the 1950's tax rates... we had jobs then, and the country had enough money to build one of he largest public works projects... the Interstate Highway system.

11/01/2010 6:12 PM
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I keep hearing all these tea party supporters say they want to take the country back, because they are losing their freedoms.   What freedoms have you lost?  The only thing that has changed is that we have a democrat as President who happens to be black and people think they have lost all freedoms.   This is totally ridiculous..
11/01/2010 2:43 PM
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But can or will Obama renege on his campaign promises?
11/01/2010 12:35 PM
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I have been saying this in these spaces since January 2009. No jobs created by higher taxes.

As an employer, I am not working harder for less. Marginal tax rates to employers matter. No hiring, and no investment by me.

I prefer to take more leisure and await the next Reagan. Why take a risk for less return and a longer investment payback?

This is a Capital Strike.

So I will mark time by taking off Sunday, Saturday, and Friday. You will do OK with your resume killing Green hope and change jobs.

Same thing happened in the 30s, and 70s. Wake up!

10/31/2010 12:23 PM
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 Over 80% of u.s. socialism is from social security, medicare. + our defense spending. So what do we cut. Every reitired person I knows says don't cut MY S.S. or medicare. I already have to work to age 67 to collect full (soon to be 70). Privitize S.S.( be reasonable,how many people can invest in this market smartly). Only 10% of our population plays the stock market, leaving 90% clueless. So Bush failed(started with surplus ended with largest def.) Oboma failed(now made largest def. even larger). Now we go back to Bush era on tue. Our voters keep jumping on and off the bandwagon and nobody has a clue whats right. Lets hope this can be replay of 2nd Clinton term where both parties move a little to center and figure this out. We need a 3rd party that can use the best of both parties ideas. Become Independent, this years most important party.
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