Tax Changes are Coming - A Preview of 2011

If you've been watching the news lately, reading blogs on the internet, receiving email newsletters, or simply had a tax conversation with a friend I'm sure you've heard about the pending storm of tax hikes right around the corner.  The current economic and political climate and the media are to blame for spinning the facts and fanning the flames of misconception regarding exaggerated tax increases looming in 2011.  As tax professionals we feel it is our responsibility to bring some reality into the picture and provide the facts to our clients and friends.  While no one can argue that there will be changes to the current tax code it is uncertain how these changes will play out.  The reality is the absolute worst case scenario at this point is the return of tax rates in effect prior to 2001 which are familiar to most of us. 

At the epicenter of the rhetoric are the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) along with the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).  These provisions provided for broad sweeping tax changes we have grown accustomed to in the last few years.  The provisions lowered taxes on capital gains and dividends, as well as ordinary income tax, by modifying the marginal tax brackets along with increasing the exemption threshold amount for the individual Alternative Minimum Tax.  In addition, the provisions phased out the estate tax culminating in the highly publicized zero estate tax for 2010.  So the argument is - now that these provisions are "sunsetting," how will the tax codes look in 2011?  At one side of the pendulum are those who believe that the Obama administration will simply let the 2001/2003 provisions expire and revert back to pre 2001(the worst case scenario described above) or, at the opposite end, there are those who believe that the 2001/2003 provisions will be extended or there will be new provisions put to vote.  However most believe the latter to be true.

Since the provisions EGTRRA have yet to expire, speculation on the 2011 tax outlook is all over the map.  However under the president's current budgetary proposals there would be an extension of many of the provisions for those with household income under $250,000 for filing married and $200,000 for filing single.  Below is a breakdown of the highlights of the proposed budget:

·         Income brackets will remain unchanged compared to 2009 except for the top two which would revert back to pre 2001 levels.

o   The bottom four brackets would remain at 10%, 15%, 25%, and 28%. The size of the 15% tax bracket for married taxpayers filing joint returns will continue to be twice the 15% tax bracket for individual filers, and the 28% bracket will be expanded to assure that taxpayers under the $250,000/$200,000 levels won't see their taxes rise as a result of the increase in the top two brackets. 

o   The top two brackets (currently 33% and 35%) would rise to 36% and 39.6%.

o   For married taxpayers filing jointly, the 36% rate would apply to taxable income above $250,000 less the standard deduction and two personal exemptions, and for single taxpayers it would apply to taxable income above $200,000 less the standard deduction and one personal exemption.

·         Long term capital gains and qualified dividends tax rates would not change (i.e., 0% or 15% rate) for taxpayer's under the $250,000/$200,000 thresholds but a 20% tax rate would apply to long-term capital gains and qualified dividends of married taxpayers filing jointly with income over $250,000 less the standard deduction and two personal exemptions and for single taxpayers with income over $200,000 less the standard deduction and one personal exemption.

·         The tax value of all itemized deductions will be limited to 28% for taxpayers in the 36% or 39.6% tax brackets. A similar limitation also would apply under Alternative Minimum Tax (AMT).

·         AMT relief which includes provisions to index the parameters of AMT for inflation starting at their 2009 levels.

·         The reduction of itemized deductions and personal exemptions will be reinstated for higher income taxpayers.

The proposed budget also includes an extension of the $1,000 child tax credit enacted under the 2001 act EGTRRA and the reduced earnings threshold for the refundable portion, which was enacted in the American Recovery and Reinvestment Act of 2009.  It will also extend through 2011 the optional deduction for state and local general sales taxes, and make permanent the American Opportunity Credit for higher education expenses.

While it is still unknown what will happen in 2011 it is apparent from the discussion above that taxes are not poised to go through the roof in 2011.  Although we have limited this discussion to the expiring provisions of EGTRRA and JGTRRRA, there are additional tax changes pending in 2011. These items will be addressed in a follow up newsletter along with pending 2012, 2013, and 2014 tax items.