Expiring Tax Cuts Can Mean Big Tax Increases in 2011

In 2001, the nation’s economy was rocked by the terrorist attacks of 9/11. The Government passed a far-reaching set of tax law changes called the Economic Growth Tax Relief Reconciliation Act (EGTRRA). This law provided the most sweeping range of tax cuts in our Nation’s history ($1.35 trillion over 10 years). EGTRRA has been credited with stimulating spending enough to keep us out of recession after 9/11 and it has been blamed for creating the nation’s budget deficit.

Why is this not ‘old news’? Here’s why: EGTRRA included a provision stating that all changes would sunset after ten years. This means that effective January 1, 2011 all of the tax cuts established under EGTRRA will go away and we will return to the prevailing tax law as of 2001. What does this mean to the average American? Higher taxes for all, of course!

Here are some of the changes that we could all face if the EGTRRA provisions are allowed to expire:

Tax Brackets: Currently, we pay taxes according to six tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. Unless something changes, there will be five brackets: 15%, 28%, 31%, 36%, and 39.6%. This would mean that everyone who pays taxes will see a tax increase of 3-5%.

Capital Gain Tax: Under EGTRRA, the maximum tax rate on capital gains and dividends is 15%, and people in the 10% and 15% brackets are not taxed on capital gains at all. Without action, next year the highest tax will become 20% on capital gains. Dividends will be taxed as ordinary income, which could mean taxes as high as 39.6%. This would be a huge disincentive for anyone looking to invest in capital assets.

Marriage Penalty: Before EGTRRA, couples routinely paid a “marriage penalty” to IRS. This existed because the brackets and deductions for married couples was not double what it would be for two single people, resulting in a higher tax liability for married couples than for two single people. EGTRRA corrected this problem, but it could be coming back in 2011.

Phase Outs: Pre-EGTRRA, if you were lucky (unlucky?) enough to make a good living, you found yourself forfeiting itemized deductions and personal exemptions on your tax return as a “reward”. A married couple making $170,000 or more would see their itemized deductions phased out and anyone earning more than $252,000 would start to lose credit for personal exemptions. EGTRRA raised those limits slowly before eliminating them completely this year. Next year, they’ll be back in full force unless something is done to preserve the changes.

Child Provisions: EGTRRA increased the Child Tax Credit from $500 to $1000, and made a portion of the credit refundable for families with more than one child. A refundable credit is a credit that you can take even if it exceeds the amount that you paid in for that year. Losing these provisions would mean significantly smaller tax breaks for working families.

Another credit that would be cut dramatically if EGTRRA expires is the Child Care credit. This credit is already woefully inadequate considering the cost of child care, so losing some of this one will especially hurt.

Estate Tax: This is the one change that you have probably heard about. A taxpayer who dies and leaves significant assets behind could once expect to see a good portion of that value end up in the hands of the government. Pre-EGTRRA, estates valued at over $1 million could face a tax bill of up to 50%. EGTRRA slowly reduced the tax brackets for estates, and also raised the exemption level. This year, there is no estate tax. Next year, the rules revert back to their 2001 form. This provision has led to some (not so) tongue in cheek comments about the best estate plan being to die in 2010.

If the President and Congress allow these tax cuts to expire, we will all find ourselves paying more tax next year then we will this year. There has been discussion on Capitol Hill about extending many of these provisions, but there are also talks of letting them all expire and allow the government to close the deficit. Alan Greenspan, former chair of the Federal Reserve Bank, has advised Congress to let all of the breaks expire. However, most pundits agree that at least some of the tax breaks will be saved.