WHAT IS A
“BUSH TAX CUT”
AND WHERE IS IT GOING?
F
or more than a decade, there has been quite
a bit of discussion regarding the “Bush tax
cuts.” In 2001 and 2003, the bills containing these cuts were discussed, debated, dissected, and analyzed before ultimately being passed. After passage, the conversation
turned to whether the provisions were fair
and what effect they were having on the economy. The year
2010 was dominated by talk of the upcoming expiration of
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By: Charles E. Marston,
CPA, MST, Tax Principal
S.R. Snodgrass, A.C.
the cuts at the end of the year and whether the cuts should
be allowed to expire or be renewed in some manner. Ultimately, the provisions were renewed at the end of 2010,
and a new expiration date was established, December 31,
2012. Now 2012 is here, and the expiration of the provisions is again relevant. While most people have heard the
term “Bush tax cuts” and are likely aware of their expiration date, many individuals do not understand them or the
effect of their expiration.
WHAT ARE “BUSH TAX CUTS?”
While commonly referred to as a single package of tax cuts,
the Bush tax cuts are actually the result of two pieces of
legislation passed during President George W. Bush’s first
term as President. The Economic Growth and Tax Relief
Reconciliation Act of 2001 (“2001 Tax Act”) and the Jobs
and Growth Tax Relief Reconciliation Act of 2003 (“2003
Tax Act”) were both major legislative accomplishments for
President Bush. The tax provisions included in the two Acts
contained more than 30 major changes to the Tax Code and
served to reduce the individual tax burden more aggressively than had been seen in years. There were not only tax
rate reductions across the board but also the elimination of
certain phase-outs, the expansion of popular tax credits,
the elimination of components of the so-called “marriage
penalty,” the taxpayer favorable overhaul of the estate/gift
tax, as well as reductions to the long-term capital gain tax
rate and dividend rate. In an effort to assist passage of the
bills, the tax provisions carried an expiration date of December 31, 2010. In 2010, President Obama passed the Tax
Relief, Unemployment Insurance Reauthorization, and
Job Creation Act of 2010 (“2010 Tax Act”) which extended
the life of the provisions to December 31, 2012. As things
stand now, absent any action, once January 1, 2013 comes
around, the Bush tax cuts will be no more. How will the
expiration affect you?
rate on “qualified” dividends to the lower long-term capital
gain rates, with a maximum tax rate of 15%. Today, most individual taxpayers with dividend income are paying lower
taxes due to this provision. After December 31, 2012, the
lower rate for dividends will no longer apply, and all dividend income will go back to being taxed at normal income
tax rates, which can be as high as 39.6%. This will mean a
taxpayer could see a tax rate increase of more than double
when it comes to his/her dividend income.
HIDDEN RATE INCREASE
The 2001 Tax Act phased in the elimination of two tax provisions that served to raise individual tax rates without
actually increasing rates. The first provision reduced the
allowable amount of itemized deductions for individuals
with adjusted gross income (AGI) that exceeded a certain
amount. The AGI amount, had this provision been in effect for 2012, would have been $173,650 for most taxpayers.
Once the AGI limit was reached, certain deductions, such as
state and local income taxes, mortgage interest, and charitable contributions, were reduced based on the taxpayer’s
AGI. This “hidden” tax increase was completely eliminated
as a result of the 2001 Tax Act. As of January 1, 2013, however, the limitation will be back in effect.
The second hidden increase eliminated by the 2001 Tax Act
It may be a long time before
WE SEE ANYTHING SIMILAR AGAIN
RATE CHANGES
The changes that will occur after December 31, 2012 are substantial, and it is hard to imagine any taxpayer not feeling
the effect of the changes in some way if the expirations occur. For starters, individual tax rates will go up. The bottom
10% tax rate, the lowest tax rate available, will disappear.
The new rate structure will have two rates (36% and 39.6%)
that are higher than the current maximum tax rate of 35%.
The rest of the rate schedule will shuffle from a range of 15%
to 33% to a range of 15% to 31%. In effect, what will happen
is that all individuals will go back to the pre-2001 Tax Act
days. While the rate changes will have a significant effect on
higher income taxpayers, the elimination of the 10% tax rate
will impact lower income taxpayers as well.
Perhaps the biggest impact may occur due to changes in two
tax rates that apply to specific types of income. Tax rates on
long-term capital gains and qualified dividends both saw
reductions under the 2003 Tax Act that will disappear after
2012. The long-term capital gain rate is scheduled to revert
back to a maximum rate of 20%, up from the current 15%
maximum rate. In addition, the 0% rate that is currently
available to lower income taxpayers will go away. As for
the tax rate on dividend income, the 2003 Tax Act tied the
is the personal exemption phase-out, which decreased the
allowable deduction for personal exemptions if a taxpayer’s
AGI exceeded a certain amount. The AGI amount, had this
provision been in effect for 2012, would have been $173,650
for single taxpayers and $260,500 for married taxpayers filing a joint return. Like the itemized deduction limitation,
this phase-out has also been completely eliminated as of
2012, but once 2013 arrives, it will be back.
MARRIAGE “PENALTY”
Married taxpayers have historically incurred a “penalty”
when compared to individual taxpayers due to how the
Tax Code’s components work together. Two of these components were the tax rate schedule and the standard deduction. Prior to the 2001 Tax Act, the income level for the
lowest tax rate for married taxpayers was equal to only
167% of the level for single taxpayers. Married taxpayers
were also disadvantaged when it came to the standard deduction, which was also set at 167% of the amount available to single taxpayers. The 2001 Tax Act corrected these
two “penalties” by setting the income level for the lowest
tax rate for married taxpayers and the amount of the standard deduction available to married taxpayers to 200%
of the amounts for single taxpayers. After 2012, however,
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married taxpayers will again feel the pain of the “marriage
penalty” in these two areas, as the rules prior to the 2001
Tax Act come back into existence.
POPULAR TAX CREDITS
One of the most popular tax credits available to individuals will be cut in half after 2012. The child tax credit was increased to a maximum of $1,000 per qualifying child by the
2001 Tax Act. The expiration of the Bush tax cuts will see this
credit reduced back to its previous maximum amount of $500
per qualifying child. In addition to increasing the amount of
this credit, the 2001 Tax Act also provided beneficial adjustments to the amount of the credit that could be considered
refundable and the amount of the credit that could be used to
offset an individual’s alternative minimum tax (AMT). After
expiration, these adjustments will no longer apply.
Other popular tax credits will also see changes that are not
favorable to the taxpayer after 2012. Changes include either
reducing the credit amount, decreasing the amount of income levels for phase-outs, changing how a credit can be
used for AMT, and/or eliminating other advantageous alterations made to the credits. The credits that will be affected include the child and dependent care credit, the adoption credit, the employer-provided child care credit, and the
earned income tax credit.
ESTATE TAX/GIFT TAX
The maximum estate tax exemption for 2012 is $5.12 million. The estate tax rate for 2012 is 35%. These amounts,
compared to the pre-Bush tax cut years, are extremely favorable to taxpayers, and are the product of the 2001 and
2003 Tax Acts. After 2012, the estate tax exemption is scheduled to revert back to $1 million and the maximum estate
tax rate will increase to 55%. Gift tax rates and exemptions
are scheduled to change in similar ways after 2012.
OTHER DEDUCTIONS/EXCLUSIONS
There are other deductions and exclusions which were either created, increased, or modified by the 2001 and 2003
Tax Acts. The expiration of these provisions after December 31, 2012 will cause adverse results for many individual
taxpayers. The provisions that are scheduled to be affected
include the educational assistance exclusion, Coverdell Savings Account contributions, student loan interest deductions, and parts of the small business stock exclusion.
There are also several provisions that, while not included in
either the 2001 or 2003 Tax Acts, were passed either as part of
the 2010 Tax Act or other tax legislation, that have become associated with the Bush tax cuts, despite being passed while
President Bush was out of office. These provisions are due to
expire after December 31, 2012 as well. Included among these
provisions are the state sales tax deduction, the teacher’s classroom expense deduction, the mortgage insurance deduction,
the exclusion for charitable contributions of IRA distributions,
and popular payroll tax cuts in effect the past few years.
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WHAT IS NEXT?
All of the changes described above will occur absent some
action by Congress and the President prior to January 1,
2013. While it is certainly in the realm of possibility that a
deal similar to the 2010 Tax Act could be reached to save
all or some of the tax cuts, it does not seem likely. With the
2012 presidential election coming in November, the possibility of a lame duck Congress, and the overall environment
that exists in Washington, D.C. today, very few people are
holding out hope that anything similar to the 2010 Tax Act
will arrive to save the day. If the expected occurs, and most,
if not all, of the Bush tax cuts expire, taxpayers should enjoy the final few months of 2012
because after that, it may be a
long time before we see anything similar again.
Chuck, a Tax Principal
at S.R. Snodgrass, A.C.,
has 20 years of experience in corporate return
preparation and overall tax planning. He is
proficient in compliance
issues and interpreting the complexities
in IRS, state, and local taxing entities as they relate to the banking industry.