Your $500-Billion Tax Bill

Washington’s inability to act on federal taxes means an unprecedented tax increase awaits us in January.  The Washington Post has termed it,
“Taxmageddon,” and Curtis Dubay at the Heritage Foundation has calculated the
total increase at $494 billion — just for 2013. An increase of that size has never occurred in a single decade, never mind a single year. Almost as bad as the looming tax bill is the uncertainty surrounding it. 

Breaking Down the Increase. More than a third of the tax increases will come from the end of the Bush-Era tax cuts. Broadest reaching of these cuts
was the across-the-board tax rate reductions. For example, married couples lucky enough to be in the 35 percent bracket (income of $388,350 and above) will see that bracket increase to 39.6 percent. Working down the brackets, the
33 percent bracket will go to 36 percent, the 28 percent bracket will go to 31
percent, the 25 percent bracket will go to 28 percent, and the 10 percent
bracket (taxable income of $17,400 or less) will disappear — making the lowest
tax bracket 28 percent.

Higher-income families will be subject to sneakier tax increases as well. Beginning in 1986, but temporarily repealed by the Bush era tax cuts, higher-income taxpayers had their itemized deductions and tax exemptions reduced, if their taxable incomes exceeded threshold amounts. Those deduction and exemption cutbacks are due to come roaring back with the bracket increases. Rate increases are also on the books for long-term capital gains (from 15 to 20 percent) and stock dividends (from 15 percent to ordinary income rates). 

All that is just the start. Another quarter of the tax increase is scheduled to come from the expiration of the two percent cut in Social Security taxes (raising the full employment tax burden back to 7.65 percent), and another quarter from the expiration of the latest Alternative Minimum Tax amelioration. 

Of the remaining tax increases, the two most talked about are the increased coverage of the federal estate tax and the Medicare surcharge on those at higher incomes. If nothing more is done, the federal estate tax will apply to estates of $1 million or more, down from the current $5 million threshold. Moreover, the tax rate will rise from its current 35 percent to 55 percent. As an added blow, a married couple can no longer transfer any unused exemption between themselves.

All of this is expiring relief from pre-existing tax rules. A much smaller piece of the tax increase comes from the new Medicare surcharge on high-income taxpayers and increased threshhold (from 7.5 percent of income to 10 percent) for taking medical deductions. The Medicare surcharge comes
in two pieces.

First, to the extent earned income (wages and self-employment income) exceeds $250,000 for a married couple filing jointly ($200,000 for a single filer), there is an additional 0.9 percent Medicare tax on that income.  All
earned income is already subject to 2.9 percent Medicare tax (borne equally by
the employee and employer, or borne all by the self-employed), so this brings
the total tax rate to 3.8 percent. 

Second, to the extent these taxpayers have net investment income in excess of that $250,000 or $200,000 total income, the net investment income is subject to the entire 3.8 percent surtax. This is what gets the total tax burden to that 43.4 percent you see bandied about. Certain classes of income — namely, Social Security benefits, pensions, and other retirement
income — are exempt from this 3.8 percent surcharge.

Handicapping Congressional Action. Congress is in a tough spot here, even if the two houses were capable of working together. Allowing $500 billion of tax increases to become effective simultaneously is politically untenable. If Congress can’t act by the end of the year, the primary effect won’t be on a few billionaires.  Anyone drawing a paycheck will be hit — and hit hard.  Without tax law changes in place by Jan. 1, employers will be forced to withhold for taxes as if all the tax
law changes will occur, and employees will bear the brunt of it. The lower an employee’s salary, the higher percentage the tax hit. Those who pay most of their taxes in quarterly installments won’t feel the pain until mid-April. 

Without knowing what will happen next year, specific advice is hard to come by.  However, it’s a safe bet that taxes will not decrease. Therefore, it may make sense to accelerate income when possible — harvest your taxable gains this year rather than next. If you turn 70-1/2 this year, do not delay taking your first minimum required distribution from your retirement plans. 

Note: Claire E. Toth, JD, MLT, CFP™, is Vice President of Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit. The full-length version of this article is available at: ptview.com.