With the first presidential debate behind us, there are still questions on what changes are coming next year with our taxes. With the president modestly ahead in the polls a month ahead of the election, here’s our tax outlook for next year depending on who the voters send to the Oval Office.
Changes that won’t be affected by the election. Many taxpayers are mired in a pre-election muck about making moves to manage their finances. Sure the election is important, but there are many tax issues are in effect settled right now.
For the past two years, we have enjoyed a payroll tax cut of 2 percent. If you earn $100,000, then you have been paying $2,000 less per year in Social Security tax. In spite of reports of the 47 percent who don’t pay taxes, this is a tax that everyone with earned income pays. There is bipartisan support for letting this tax cut expire at the end of this year. Most of you should expect a 2 percent pay cut in January.
Second, for couples with an AGI over $250,000 and single earners over $200,000, there will be an additional Medicare tax of 3.8 percent on investment earnings. Investment earnings include dividends, interest, capital gains, real estate proceeds, and other passive income.
This change is unprecedented as throughout Medicare’s history, it has been a payroll tax. Now it’s levied at 1.45 percent of earned income plus a .9 percent increase starting next year for joint filers with an AGI above $250,000 and single filers over $200,000.
Finally the perennial alternative minimum tax kabuki will soon commence. The AMT primarily impacts high income earners, particularly those with a lot of deductions and dependents. Congress will pass another last-minute AMT “patch” by year’s end, keeping tens of millions of us from seeing an unexpected jump in what we owe the IRS this year.
With Obama’s re-election, we could prepare for the Bush tax cuts to expire at the end of the year. Current law calls for dividend tax rates to increase to ordinary income levels. Tax rates would be hiked across the board including on long-term capital gains. Exemptions and itemized deductions would once again disappear as income goes up.
However, experts don’t expect all of these changes to come into effect. Instead, look for long-term capital gains to increase to 20 percent as planned but dividend rates to be kept at that same level. One possibility is that tax rates next year will stay the same as 2012 but with deductions limited for high income earners. This is the one deal that can raise government revenue, keep taxes low for the middle class, and raise effective taxes on the wealthy while still allowing politicians who signed a tax pledge to support it.
With a Romney victory, look for tax rates next year to be held at today’s rates for earned income, dividends, and capital gains excepting the Medicare changes, which will be extremely hard to repeal. This could be accomplished through a lame duck session approving a one year extension of current income and estate tax rates, with wider reaching reform next year especially if the Republicans win the Senate.
“It’s tough to make predictions especially about the future,” Yogi Berra once said. The above is an educated guess of what could happen. We’ll have extensive coverage about the changes after the election so you can take critical steps to before the end of the year. Be ready, because in the months ahead there’s much to be done to improve your financial health.
Dave Gardner is a certified financial planner in Boulder and is admitted to practice before the IRS. He can be reached through his web site at yellowstonefinancial.com.