What Happens If the Bush Tax Cuts Expire

The folks at Americans for Tax Reform, a non-partisan coalition of taxpayers and taxpayer groups who oppose all tax increases, released Tuesday a helpful reminder of just what is at stake in the debate over extending the current tax rates, which are set to expire at year’s end.

“If Congress doesn’t act, everyone who pays taxes will see a tax hike in their first paycheck of the year,” ATR says. “The tax hike will hit the small business sector especially-hard, since small businesses pay taxes at the individual tax rates. You can’t raise taxes on people without also raising taxes on small employers.”

The tax hikes, the group says, come in three waves:

First, the 2001 and 2003 tax cuts for investors, small business owners, and families will all expire on January 1, 2011 unless Congress and the president act to extend them. In addition, personal income tax rates will rise.

The top income tax rate will rise from 35 to 39.6 percent (this is also the rate at which two-thirds of small business profits are taxed). The lowest rate will rise from 10 to 15 percent. All the rates in between will rise. Itemized deductions and personal exemptions will again phase out, which has the same mathematical effect as higher marginal tax rates.

• The 10 percent bracket rises to an expanded 15 percent
• The 25 percent bracket rises to 28 percent
• The 28 percent bracket rises to 31 percent
• The 33 percent bracket rises to 36 percent
• The 35 percent bracket rises to 39.6 percent

There will also be higher taxes on marriage and family. The “marriage penalty” (narrower tax brackets for married couples) will return from the first dollar of income. The child tax credit will be cut in half from $1,000 to $500 per child. The standard deduction will no longer be doubled for married couples relative to the single level. The dependent care tax credit will be cut.

The death tax also returns. This year, there is no death tax. For those dying on or after January 1, 2011, there is a 55 percent top death tax rate on estates over $1 million. A person leaving behind two homes and a retirement account could easily pass along a death tax bill to their loved ones.

And there will be higher tax rates on savers and investors.

The capital gains tax will rise from 15 percent this year to 20 percent in 2011. The top dividends tax will rise from 15 percent this year to 39.6 percent in 2011. These rates will rise another 3.8 percent in 2013, says ATR.

The second wave is the more than 20 new or higher taxes associated with Obamacare, several of which go into effect on January 1, 2011 and which include:

• The Tanning Tax, which went into effect on July 1st of this year. It imposes a new, 10 percent excise tax on getting a tan at a tanning salon. “There is no exemption for tanners making less than $250,000 per year,” says ATR.
• 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).
• The HSA Withdrawal Tax Hike. This provision of Obamacare increases the additional tax on non-medical early withdrawals from an HSA from 10 to 20 percent, disadvantaging them relative to IRAs and other tax-advantaged accounts, which remain at 10 percent.
• Brand Name Drug Tax. Starting next year, there will be a multi-billion dollar tax imposed on name-brand drug manufacturers. This tax, like all excise taxes, will raise the price of medicine, hurting everyone.
• Economic Substance Doctrine. The IRS is now empowered to disallow perfectly-legal tax deductions and maneuvers merely because it judges that the deduction or action lacks “economic substance,” an obviously an arbitrary empowerment of IRS agents, says ATR.

The third wave involves the Alternative Minimum Tax and Employer Tax Hikes.

“When Americans prepare to file their tax returns in January of 2011, they’ll be in for a nasty surprise—the AMT won’t be held harmless, and many tax relief provisions will have expired,” ATR says, identifying as the major items:

The AMT will ensnare over 28 million families, up from 4 million last year. 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. These families will have to calculate their tax burdens twice, and pay taxes at the higher level. The AMT was created in 1969 to ensnare a handful of taxpayers.

Homeowner Paperwork Tax Burden. President Obama recently signed a small business bill which has several tax hikes and tax breaks. One of the tax hikes requires the 10 million homeowners who rent out second homes and vacation homes to issue burdensome “1099-MISC” forms to everyone with whom they do more than a small amount of business. This will result in millions of wasted hours filling out paperwork and being chased by the IRS. 90 percent of people who rent out homes make less than $200,000 per year.

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, many others. Combining high marginal tax rates with the loss of this tax relief will cost jobs.

Tax Benefits for Education and Teaching Reduced. The deduction for tuition and fees will not be available. Tax credits for education will be limited. Teachers will no longer be able to deduct classroom expenses. Coverdell Education Savings Accounts will be cut. Employer-provided educational assistance is curtailed. The student loan interest deduction will be disallowed for hundreds of thousands of families.

Charitable Contributions from IRAs no longer allowed. Until this year, a retired person with an IRA could 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.

It’s a big list, covering everything from soup to nuts, which is why President Barack Obama and the congressional leaders who are meeting at the White House Tuesday have an incentive to act. The political consequences of inaction on these key issues are just too high, especially with the economy in the dire straights it currently is.

• See an Opinion slide show of 8 Ways To Sell Deficit Reduction.
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