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2012 Expiring Tax Cuts

If you have been following the news lately, then it is likely that you read or heard about the so-called “Bush tax cuts” and other tax cuts that are set to expire at the end of the year unless Congress takes action to extend them. What if they do expire? How would it affect you? Here are the changes that would most likely affect you if the tax cuts were allowed to expire.

Payroll Tax – 2% Increase

There are several different payroll taxes, but the largest is the Federal Insurance Contributions Act (“FICA”) tax. This tax is composed of two pieces: Social Security and Medicare. If you are a wage or salaried employee, then have been paying 5.65% on each dollar you earn in FICA taxes (4.2% for Social Security and 1.45% for Medicare). However, at the end of the year, Social Security will return to the original 6.2% rate, making your total FICA tax rate 7.65%. This 2% increase also applies to anyone who is self-employed, increasing self-employment taxes from 13.3% to 15.3%.

Alternative Minimum Tax “Patch” – Lower Exemption Amount

The Alternative Minimum Tax (“AMT”) is a separate income tax that is generally paid by middle and upper-middle income taxpayers. The AMT “patch” increases the amount of income that is exempt from the AMT calculation, which means fewer taxpayers are subject to the AMT. Although the AMT patch officially expired last year, Congress has consistently extended this provision in the past, so there is a possibility the patch would be extended retroactively for the 2012 tax year. However, if the patch were not extended, then millions more taxpayers would owe the AMT.

Capital Gains and Qualified Dividends – Tax Rate Increase

Currently, the maximum tax rate for long-term capital gains and qualified dividends is 15%. However, the maximum rate for long-term capital gains would increase to 20% and qualified dividends would no longer receive preferential treatment, but would be taxed as ordinary income and become subject to the taxpayer’s ordinary tax rate.

Standard Deduction for Married Couples – Decrease

The standard deduction for married couples has been 200% or twice the standard deduction for single filers, but would decrease to just 167% after this year. In dollar terms, the standard deduction for married couples would decrease from $11,900 (in 2012) to $9,950 (in 2013). Because individuals are allowed to take the greater of the standard deduction or itemized deductions (such as state taxes, mortgage interest, charitable donations, etc.), this change would only apply to those who do not itemize their deductions.

Child Tax Credit – Decrease

The child tax credit would decrease from $1,000 to $500 per eligible child.

Tax Rates and Brackets

There are currently six tax rates based on set levels, or brackets, of income – 10%, 15%, 25%, 28%, 33%, and 35%. In 2013, the 10% bracket would disappear and taxable income once subject to the 10% rate would be combined with the 15% rate bracket. Also, the tax rates in the top four brackets would see increases to 28%, 31%, 36%, and 39.6%.

College Tuition Credit – Decrease in Amount and Number of Years Available

Right now, qualifying college students or parents of college students may claim the American Opportunity Credit. This credit has a maximum credit of $2,500 (40% is refundable) and is available for up to four years of education. However, the American Opportunity Credit would expire, leaving those with education costs with the Hope Credit. This would effectively decrease the maximum credit to $1,800 (no refundable portion) and would only be available for two years.

Earned Income Tax Credit – Phase-out Decrease for Married Couples

The Earned Income Tax Credit (“EITC”) generally benefits low and medium income individuals and couples with children, whose income falls within a specified range. The credit is phased out once income exceeds phase-out amounts. Currently, married taxpayers enjoy a higher phase-out level than unmarried taxpayers. However, if the tax cuts expired, then the phase-out level for married taxpayers would decrease by $3,000 to equal the level for unmarried taxpayers.

Estate Taxes – Increased Rate and Lower Exemption

The top tax rate for estates is currently scheduled to increase from 35% to 55% and the exemption amount would be lowered from $5 million to $1 million. Please see our blog post, “2012 The Year of the Gift”, for more details.

* * * Please note that each of these tax cuts (aside from the AMT “patch” that expired at the end of 2011), if allowed to expire at the end of this year, would affect your 2013 tax return (filed in 2014). Also, all of these tax cuts apply to individual taxes only; not businesses. If you have any questions concerning possible changes that may affect you, please contact us.

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