Liberty on Tap since 1984

Up, Up, & Away!

In just three months, on January 1, 2011, the largest tax hikes in the history of America will take effect.
They will hit families and small businesses in Three Great Waves. I normally like to provide "short and to the point" information, but the topic of Increasing Tax Rates requires some more detailed information.

On January 1, 2011, here is what will happen:

First Wave:

Expiration of 2001 and 2003 Tax Relief:

1. In 2001 and 2003, the GOP Congress enacted several tax cuts for investors, small business owners, and families. These will all expire on January 1, 2011.

Personal Income Tax Rates will Rise:

1. The top income tax rate will rise from 35% to 39.6% (this is the rate at which two-thirds of small business profits are taxed).

2. The lowest rate will rise from 10% to 15%. All the rates in between will also rise.

3. Itemized Deductions and Personal Exemptions will again phase out, which has the same mathematical effect as higher marginal tax rates.

The full list of marginal rate hikes is listed below:

1. The 10% bracket increases to an expanded 15%

2. The 25% bracket increases to 28%

3. The 28% bracket increases to 31%

4. The 33% bracket increases to 36%

5. The 35% bracket increases to 39.6%

Higher taxes on marriage and family:

1. The "marriage penalty" (narrower tax brackets for married couples) will return from the first dollar of income.

2. The child tax credit will be cut in half from $1,000 to $500 per child.

3. The standard deduction will no longer be doubled for married couples relative to the single level.

4. The dependent care and adoption tax credits will be eliminated.

The return of the Death Tax:

1. This year only, there is no death tax. (However, it is a scam!) For those dying on or after January 1, 2011, there is a 55% Top death tax rate on estates over $1 million.

2. A person leaving behind two homes, a business, a retirement account, could easily pass along a death tax bill to their loved ones. Think of the farmers who don’t make much money, but their land, which they purchased years ago with after-tax dollars, is now worth a fortune.

3. Their children will have to sell the farm, which may be their livelihood, just to pay the estate tax if they
do not have the cash sitting around to pay the tax. Think about your own family’s assets. Maybe your family owns real estate, or a business that does not make much money, but the building and equipment are worth $1
Million. Upon their death, you can inherit the $1 Million business tax free, but if they own a home, stock, or cash worth $500,000 on top of the $1 million business, then you will owe the government $275,000 cash!

4. That is 55% of the value of the assets over $1 million! Do you have that kind of cash sitting around waiting to pay the estate tax?

Higher tax rates on savers and investors:

1. The capital gains tax will rise from 15% this year to 20% in 2011.

2. The dividends tax will rise from 15% this year to 39.6% in 2011.

3. These rates will increase another 3.8% in 2013.

Second Wave:

Obamacare:

There are over twenty new or higher taxes in Obamacare. Several will go into effect on January 1, 2011. They include the following:

1. The "Medicine Cabinet Tax" - Thanks to Obamacare, Americans will no longer be able to use health savings account (HSA), flexible spending account (FSA), or health reimbursement (HRA) pre-tax dollars to purchase non-prescription, over-the-counter medicines (except insulin).

2. The "Special Needs Kids Tax" - This provision of Obamacare imposes a cap on flexible spending accounts
(FSAs) of $2,500 (Currently, there is no federal government limit). There is one group of FSA owners for whom this new cap will be particularly cruel and onerous: parents of special needs children. There are thousands of families with special needs children in the United States, and many of them use FSAs to pay for special needs education.

3. The HSA (Health Savings Account) Withdrawal Tax Hike - This provision of Obamacare increases the additional tax on non-medical early withdrawals from an HSA from 10% to 20%, disadvantaging them
relative to IRAs and other tax-advantaged accounts, which remain at 10%.

Third Wave:

1. The Alternative Minimum Tax (AMT) and Employer Tax Hikes - When Americans prepare to file their tax returns in January of 2011, they will be in for an unwelcome surprise - the AMT will not be held harmless, and
many tax relief provisions will have expired. The major items include:

a. The AMT will ensnare over 28 million families, up from 4 million last year.

b. According to the left-leaning Tax Policy Center, Congress' failure to index the AMT will lead to an explosion of AMT taxpaying families-rising from 4 million last year to 28.5 million.

c. These families will have to calculate their tax burdens twice, and pay taxes at the higher level. The AMT was created in 1969 to deal with a only a small portion of taxpayers.

Taxes will be raised on all types of Businesses:

There are literally scores of tax hikes on business that will take place. The biggest is the loss of the "research and experimentation tax credit," but there are many others. Combining high marginal tax rates with the
loss of this tax relief will cost jobs.

Tax Benefits for Education and Teaching Reduced:

1. The deduction for tuition and fees will not be available.

2. Tax credits for education will be limited.

3. Teachers will no longer be able to deduct classroom expenses.

4. Coverdell Education Savings Accounts will be cut.

5. Employer-provided educational assistance is curtailed.

6. The student loan interest deduction will be disallowed for hundreds of thousands of families.

Charitable Contributions from IRAs no longer allowed:

Under current law, a retired person with an IRA can contribute up to $100,000 per year directly to a charity from their IRA. This contribution also counts toward an annual "required minimum distribution." This ability will no longer be there.

I know this is a lengthy document to digest, but this is what we face if Congress does NOT act to extend the tax cuts that are set to expire on December 31, 2010.

Tags: Congress, Economy, Fiscal Policy, IRS, Personal Finance, Politics, Taxes

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Comment by Marcotte Anderson on September 20, 2010 at 7:10pm: Kevin,
What's your take on my point about consumer spending? Do you agree, or disagree, and why? I'm interested in hearing your thoughts, as someone with a different philosophical view about taxation, yet one who also obviously has experience and knowledge and puts some critical thought into these issues.

I hope this information helps illustrate who pays what percentage of the Total Tax Burden for the United States.
Your link does do that, but however that is not exactly relevant to the point at hand. Perhaps I was to brief in my comment. I wasn't disputing the ratio of the "taxes" paid by each of the 10 men in your parable. (Though, for what it's worth, based on your link, the numbers in the parable don't seem right - at no time between 1999 and 2007 did the top 10% contribute 59% of the taxes, it was actually higher than that at 65%-71%.)

What I was getting at was the change in tax burden in the parable didn't seem to reflect the actual change in tax burden. I read it too quickly, however, assuming that the reduction was proportional for all men, but I see now that I was wrong about the rich man.

He saw his tax go down from $59 to $52, or about 12%. In real life, the top bracket decreased from 39.6% to 35%, also about 12%. However, for the 2nd richest man, he saw his burden go from $18 to $12, a whopping 33%. But in reality, those in the 2nd highest bracket saw only an 8% decrease in their top marginal rate.

Now, this analysis is fraught with confounding issues. The marginal rate is not equal to the effective rate for one, and I don't think the top 10% of taxpayers are in the highest bracket (nor is the 2nd decile solely in the 2nd bracket). I think the conclusion I have to draw is that trying to distill the effects of the 2001 tax cuts down into a simple parable is well intentioned, but ultimately problematic.

Comment by Kevin R Mullins on September 19, 2010 at 1:21pm: Marcotte:

The Tax Cut Parable is 100% Factual. It uses an illustration to show how the tax effects of the Bush Tax Cuts during 2001. Rather than providing a lengthy explanation of the details, I am providing a link below that shows the percentage of taxes paid by income level.

The source for the data is released by the IRS on an annual basis.

http://www.ntu.org/tax-basics/who-pays-income-taxes.html

I hope this information helps illustrate who pays what percentage of the Total Tax Burden for the United States.

Comment by Marcotte Anderson on September 19, 2010 at 9:44am: Another popular alternative is setting up a Family A-B Trust
Yeah, that's what I was referring to. There is also something called a Q-tip Trust that goes along with it, though I don't really understand the details. The fact that you have 3 "separate" trusts is what gets you up to the $3 million threshold.

However, I feel if we had lower taxes and more certainty, consumers would begin to spend again. In addition, this would create jobs that would allow more people to buy products and services.
I completely agree. And so do the Democrats (and Republicans) which is why they want to extend the cuts for the vast majority of consumers. It's important to note that cutting the taxes of someone making $50k by $100 is going to lead to almost $100 in consumer spending, while cutting taxes of someone making $250k by $100 is going to lead to an increase of something less than that. In other words, to spur consumer spending (which we've established is the largest single driving factor in our economy, and thus should be our #1 priority), you get more bang for your reduced tax buck by reducing taxes on poorer people.

The wealthiest people in the United States already pay the overwhelming portion of taxes.
This would still be true under a flat tax. It could even be true under certain regressive schemes. The simple fact of the matter is that those taxpayers you make more money are going to necessarily pay more taxes.

Your parable is nicely crafted, but a bit misleading. The 2001 tax cuts cut the top bracket by 4.6% points, while the other brackets in the middle dropped by only 3% points.

Comment by Kevin R Mullins on September 18, 2010 at 2:10pm: Marcotte:

Thanks for your response. In answer to your questions, my answers are listed below:

1. Your comment regarding establishing a Trust is a "best practice" for Estate Planning. However, it has been surprising to me regarding the number of people that do not actually follow through with this plan. Another popular alternative is setting up a Family A-B Trust. I have always felt that we are taxed enough while we are living and having to pay a tax for death has always appeared immoral.

2. The United States has had a lower savings rate in comparison with other developed countries since the 1970's. Savings is a good thing and I wish our Government would adhere to the same principals that many of our consumers are participating in at this time (Less Debt & Less Spending). I agree that Consumers make up 67% of our Gross Domestic Product (GDP) and this is a driver for our economy. However, I feel if we had lower taxes and more certainty, consumers would begin to spend again. In addition, this would create jobs that would allow more people to buy products and services.

3. Please refer to my post "A Tax Cut Parable" for more information on the impact of tax increases. The wealthiest people in the United States already pay the overwhelming portion of taxes. Our Progressive Tax System is one that punishes prosperity and our Country was Founded on giving Individuals the right to prosper. If you are going to extend tax cuts, they should be for everyone. Otherwise, you are engaging in "class warfare". Individuals respond to tax incentives as well as tax de-centives. If we raise taxes on the wealthy, it will be disastrous for our economy.

One last thought, I can remember back in the 1980's when the Wealthy was defined as a person with Income Greater than $1 Million Dollars. Without adjusting for inflation, how did the Definition of Wealthy change to a person with Income Greater than $250,000?

I hope I answered your questions. Thanks again for your response.

Comment by Marcotte Anderson on September 17, 2010 at 2:00pm: there is a 55% Top death tax rate on estates over $1 million.
Anyone with enough assets to worry about estate tax should set up a Revocable Living Trust (our lawyer charged us around $3000). This will allow you to avoid paying taxes on up to the first $3 million.

Higher tax rates on savers and investors:
There is a silver lining here. As our savings rate increases, we are spending less money. The largest single factor driving the economic recovery is consumer spending, so to the extent that this causes people to save less, we will stimulate the economy.

(The following is my general understanding of the current political debate on this issue [excluding the 2nd wave - Health Care Reform], so I may have some things wrong. Please correct me if necessary.)

It should be noted that the Republicans want to basically do away with all of these, while the Democrats want to do away will most of these. Hopefully the Republicans won't be so stubborn as to not allow negotiation and compromise, because if the Bush Cuts go away in their entirety, it will probably slow down what recovery we do have. Unfortunately, I wouldn't put it past the GOP to stonewall on this issue and then blame the Democrats later when the higher tax rates slow down the recovery.

Up, Up, & Away!

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