In 2001 and 2003, President Bush enacted a series of tax cuts that lowered income taxes for just about everyone - not only the rich. These tax cuts will expire on December 31, 2010. So far, although both Democrats and Republicans have come up with plans to renew the tax cuts (with some changes), Congress has not actually taken action. Here's a look at what will happen if Congress allows the Bush tax cuts to expire. (Find out more in A Concise History Of Changes In U.S. Tax Law.)
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1. Federal Tax Rates Increase - For Everyone
The lowest federal tax bracket, aside from those individuals who pay no income tax, is currently 10%. This rate applies to individuals with annual taxable incomes in the range of $6,050 to $10,425. If the tax cuts expire, the lowest bracket would become 15%. Every other bracket will increase by 3% except for the current top bracket of 35%, which would increase to 39.6%.
2. Marriage Penalty Increases
When two people get married, their tax liability sometimes increases and sometimes decreases. The change depends on a number of factors, including the couple's joint income. The "marriage penalty" refers to the fact that some couples see their tax liability increase when they get married compared to what they paid when they were single. Right now, the marriage penalty generally only affects high-income couples, but if the tax cuts expire, it will affect lower tax brackets, too.
3. Increased Capital Gains Taxes
Currently, people in the lowest two tax brackets, the 10% and 15% brackets, pay no taxes on long-term capital gains (gains on assets that have been held for at least one year before being sold). Everyone else pays a 15% rate on long-term capital gains. If the tax cuts expire, individuals in the lowest tax bracket (which would be the 15% bracket, increased from the current 10% bracket) would pay 10% on long-term capital gains; everyone else would pay 20%.
Short-term capital gains rates will also increase. The current short-term capital gains tax rate is equal to the taxpayer's marginal tax rate. Since marginal tax rates will go up if the tax cuts expire, short-term capital gains rates would also go up. (For more, see Tax Effects On Capital Gains.)
4. Tax Rate on Dividends Goes Up
The top tax rate on dividends used to be equal to the taxpayer's marginal tax rate. The Bush tax cuts lowered the top rate to 15%. If the tax cuts expire, taxpayers will again pay their marginal tax rate on dividends.
5. Child Tax Credit Cut In Half
The child tax credit is a federal tax break designed to reduce taxes for people with children. Currently, the tax credit provides $1,000 in relief for every qualified child younger than 17. If the tax cuts expire, the break will go back to being only $500 per qualified child.
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6. Personal Exemptions Phased Out - Again
In 2010, taxpayers may take a personal exemption of $3,650 for themselves, their spouses and each qualified dependent. The exemption directly reduces the taxpayer's taxable income - no tax is paid on exempt income. In 2010, this exemption does not phase out as the taxpayer's income increases, but as recently as 2009, the exemption began to phase out at "$125,100 for married persons filing separately; $166,800 for single individuals; $208,500 for heads of household; and $250,200 for married persons filing jointly or qualifying widow(er)s," according to the IRS. And the most a taxpayer could lose was one-third of his exemption. If the tax cuts expire, the phase outs will return.
7. Itemized Deductions Disappear
Many taxpayers, especially homeowners, choose to itemize their tax deductions so that expenses such as mortgage interest, property taxes, state income taxes and charitable contributions will reduce their total tax liability. They do this when their itemized deductions are higher than the standard deduction. In 2010, the standard deduction is $5,700 for single taxpayers, $8,400 for heads of household and $11,400 for taxpayers who are married filing jointly.
Under a law that went into effect in 1991, taxpayers with earnings above a certain threshold who chose to itemize their deductions no longer received the full value of their itemized deductions. The phase-out thresholds were set in 1991 at $100,000 for married filing jointly taxpayers and $50,000 for all other taxpayers. These amounts were indexed to inflation.
The law was controversial, and the 2001 Bush tax cuts reduced its sting, eliminating it gradually from 2006 to 2009 and completely in 2010. However, if the tax cuts expire, the itemized deduction phase-out will return.
8. The Estate Tax Returns
In 2010, estates of any value are not taxed when the owner dies. In 2011, the estate tax rate is scheduled to return back to 55% on estates values in excess of $1 million. (To learn more about the estate tax, read Get Ready For The Estate Tax Phase-Out and Planning For The Estate Tax's Return.)
Will Your Tax Bill Go Up?
Some commentators like to point out that the tax increases we would see in 2011 are not actually "increases", but a return to the way things were before the tax cuts were implemented. However, after living with these tax cuts for so long, they seem like a permanent fixture - especially for young workers who never knew the higher rates. There's no denying that higher tax rates stunt economic growth and reduce entrepreneurship and incentives to work. These effects of taxation are never a good thing, but their harmful effects would be more pronounced in today's unfavorable economic climate.
Ultimately, what most people want to know is, "How will these changes affect me?" To put an actual number value on how much the expiring tax cuts could cost you, try the Tax Foundation's 2011 Income Tax Calculator at http://www.mytaxburden.org/.
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