Five Upcoming Tax Hikes and What They Mean to You

by Joe Plemon on April 19, 2010

Tax by definition
Creative Commons License photo credit: alancleaver_2000

I know. Tax season just concluded and the last thing you want to hear about is taxes. I understand, but think of it this way – right now, while this stuff is fresh in your mind, is the best time to start considering what the future holds. So…are you ready?  Take a deep breath and read on.

We heard it over and over again from candidate Obama during the 2008 Presidential campaign: “I will not raise taxes on any single person earning under $200,000 or family making less than $250,000 a year.” Of course the implication is, “If you make over those thresholds, watch out!”

The Obama administration has a great opportunity to keep both the promise and the implication as taxes will undoubtedly go up.

According to MoneyWatch.com, we can expect the following tax changes:

1. Hike from Health Care Legislation

Starting in 2013, if your income is above the $200,000/$250,000 level you will pay an additional 0.9 percent on your federal payroll taxes, and your investment income and gains will be bumped up by 3.8 percent levy.

2. Higher Income Taxes for High Earners

This is an easy one. All Congress needs to do is nothing in order to raise taxes on high earners. “How can this be?” you ask. Unless the Bush tax cuts of 2001 and 2003 are extended, they expire this year, pushing the top incremental brackets back to the 2000 levels. Specifically, the top levels of 33% and 35% will revert to 36% and 39.6% respectively. The 36% increment will include singles with taxable incomes of $192,000 and married couples filing jointly with incomes above $232,950. The 39.6% bracket includes everyone (singles or married) earning above $375,000. If no action is taken, these higher rates start in 2011. All other brackets will become permanent.

Strategy

Mark Juscombe, senior tax analyst at CCH publications, says, “You might want to reverse the usual tactic of deferring income into the next year.” Also, higher earners who are converting a traditional IRA to a Roth IRA may want to pay the conversion tax at the 2010 level instead of spreading the tax bill out to 2012. Recommendation: meet with your tax advisor!

3. Investment Gains

This is another “do nothing” tax hike. Long term capital gains and qualifying dividends, which have been at a 15% maximum rate for several years, will automatically go up without Congressional action; the capital gains to 20% and the dividends to be treated as ordinary income. According to MoneyWatch.com, the most likely fix will be to lock in the dividends at 20 percent, which is certainly better for those in brackets above that level.  Also, keep in mind that if you are in the $200,00/$250,000 income levels, you will be adding another 3.8% of taxes to those gains starting in 2013 (see 1. above).

Strategy

Home owners of high value real estate who are considering down sizing would save considerably by doing so in 2010 instead of waiting. The first $500,000 capital gains for a married couple who has lived in the house for more than 24 months is not taxed, but what if the gain is $1 million? The capital gain tax difference between 15% (2010) and 20% (2011) is $25,000.

4. Return of Estate Tax

There is no federal estate tax this year (2010), but, without Congressional action, it will automatically revert to 2000 levels starting in 2011. What will this mean? Estates between $1 million and $10 million would be hit with a top rate of 55 percent while those above $10 million would pay 60%. However, Congressional leaders have promised to reinstate the 2009 rules – no tax on estates up to $3.5 million ($7 million for married couples) and a maximum rate of 45 percent on assets above that level, retroactive to January 1, 2010.

Strategy

Money Watch says, “Hope Congress gets its act together pronto – and talk to your attorney while you wait.” The current status is muddied by the fact that there is currently no 2010 federal estate tax but Congress is considering passing a bill that would make it retroactive to the beginning of 2010.

5. Fewer Write-Offs for High-Income Earners

The Obama 2011 budget calls for reinstating the phase-out of personal exemptions and itemized deductions for taxpayers in the two highest brackets. One proposal would cap the deduction rate for these brackets (36 percent and 39.6 percent) at 28 percent, which will certainly raise the ire of organizations who depend on charitable contributions.

For a great post and ensuing discussion on this topic, see Financial Samurai’s Why Are President Obama And The Democrats Against Charity?

Strategy

Hopefully, not getting a deduction in 2011 will not deter you from giving to charitable organizations, but reality is that the less taxes you pay, the more money you have to give. Tax wise, for those in the top two brackets, you might want to give an extra amount this year to offset the reduced deduction next year.

Summary

Has Obama kept his promise to not tax singles earning below $200,000 and married couples under $250,000 range?

Not exactly. The legislation he signed raising the tobacco tax nearly 62 cents on a pack of cigarettes will most certainly hit the average working class the hardest. However, the likely hikes discussed in this post will affect high earners the most.

As we said, the promise NOT to raise taxes on those earning under the given thresholds were implied promises TO raise taxes on higher earners. To that degree, President Obama is keeping his promises.

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{ 9 comments… read them below or add one }

LeanLifeCoach April 19, 2010 at 7:24 am

Very good stuff. I have made a couple notes for the future as a result. I just hope I have a chance to apply some of this as a high income earner at some point in the future!

Reply

joeplemon April 19, 2010 at 7:39 am

LeanLife,
Me too! Right now I can’t relate to the $250,000 income bracket, but I would like the opportunity to be one of those who can legitimately squawk about the government picking on the wealthy. :)

Reply

Jason @ Redeeming Riches April 19, 2010 at 8:57 am

I really hate the capital gains increase! For those with non-IRA money that has sizeable gains, an extra 5% can hurt!

Great post! There should be more talk about this stuff now so we can prepare ourselves!

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joeplemon April 19, 2010 at 9:25 am

Jason,
Right! While these other increases won’t affect most of us, the capital gains increase certainly can. As you pointed out, one doesn’t have to be in the “high earner” category to pay capital gains … and an extra 5% can hurt!

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Bryan Sr April 19, 2010 at 1:31 pm

No, Obama has not kept his promise by any stretch of the imagination.
I think it is pitiful all the tax hikes that are probably going to go back into place. I have never liked an estate tax, at least not anything close to what it was, capital gains tax, down right silly. There are many things that could be done better, even a flat tax across the board, a tax that is built into everything we purchase.
Sad, Very sad. Great post, thanks for the information.

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Arthur @ FinancialBondage.org April 19, 2010 at 5:23 pm

Obama is taxing everything under the sun. Now I know what he means by “Change”. It’s what we have left over when the democrats are done taxing everything to pay for their expanded socialist government.

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joeplemon April 19, 2010 at 6:06 pm

@Bryan Sr
Don’t misunderstand me…I am not happy about the upcoming tax hikes. I am simply saying that we shouldn’t be surprised. Most of the new hikes discussed in this post are for those who fit in the income range ($250,000 and above for married couples) that Obama, by inference, promised to target. In that regard he is keeping his promises.

@Arthur,
Yes, bigger government requires more funding…i.e. higher taxes. But, once again, we shouldn’t be surprised. As you said, he promised change. Many of us might not like the change we see, but he is keeping that promise. Our electorate gets what they vote for.

Reply

Guy G. April 19, 2010 at 8:29 pm

Hey Joeplemon,
It’s not income tax, but we’ve got a pretty hefty sales tax hike coming here in Canada too. For many items, like new homes and autos, diapers and food there was only the Federal sales tax (GST 5%). The Provincial sales tax (PST 8%) was only charged on items like computers, clothing, shoes and entertainment. They’re introducing Canada Wide (Quebec currently uses it) the Harmonized Sales Tax, which is a combination of both, totaling 13%.

The new home in my are is $200+
8% extra on that is $16,000.

Thank you government! I’ll really have to adhere to the strictest of tips on budgeting that have ever been dreamed up on. That 16k is the amount of our current savings for a down payment. I’ll have to come up with another 16k just for the tax.

Anyway,
Thanks for sharing what’s happening south of the border,
Guy

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joeplemon April 20, 2010 at 10:55 am

Guy,
Good to hear from North of the Border, I think…. Sounds like some massive tax increases are in the works there.

I would like to see the USA replace all other federal taxes with a sales tax. I wrote about the Fair Tax (http://personalfinancebythebook.com/the-fair-tax-is-it-too-good-to-be-true/) a couple of weeks ago. But even though the numbers could work, such a huge change is highly unlikely. The way politicians consider taxes is kind of like the baby sitting in a messy diaper thinking, “I know it stinks, but I made it and its mine.”

The buzz south of the border is that we are going to come up with a Value Added Tax, not to replace any outdated taxes, but to complement them.

So, Guy, you guys up there seem to be giving our guys down here ideas.

Reply

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