Potential Tax Law Changes

Taxes 101

The Bush tax cuts that are set to expire at the end of this year are in a state of flux. However, regardless of the decisions Congress makes on the cuts, it’s important to understand the potential tax changes you may face.

Tax Rates Increase

The first change you’ll see is in the marginal tax rates. Marginal tax rate refers to the rate you’ll pay on each incremental dollar you earn.is the change in the In general terms, those in the lowest and highest income brackets will see their tax rate increase. For example, low income earners will see their tax bracket go from 10% to 15%. On the other hand, “fat cats” will experience a rate increase from 35% to 39.6%. Those in the middle are affected very little by the tax rate changes. Most tax observaters believe the lower tax rates will be preserved, but it’s far from certain whether the high income earners will be given the same reprieve.

Marriage Penalty Comes Back

The marriage penalty refers to the incremental tax a couple pays over the combined tax if each were to file as single taxpayers. Thanks to the Bush tax cuts about a decade ago, the marriage penalty was eliminated by making the standard deduction for joint filers double that of the single filer. Without the Bush tax cuts extended, the joint-filer standard deduction will fall to 167% of the amount for singles.

Dividends and Capital Gains Rates Going Up

Capital gain rates, currently 0% for those in the 10% or 15% bracket are due to rise to 10% or 20% depending on your income. All others will see the capital gains rate tick up from 15% to 20%. More dramatic is what could happen to the tax rate on dividends. Most dividends, now taxed at capital gain rates (as low as 0% to 15%), will skyrocket to as high as 39.6%. Retirees who have built a portfolio of dividend paying stocks will suffer the most from this change.

College Savings Plan Get Cut

One popular and tax advantaged way to save for college is through a Coverdell Education Savings Account. Even though the contribution limit was only $2000 (hardly enough to make a dent in tuition), the contribution maximum in 2011 drops to $500. There are several other college savings plans available, so be sure to check them out before investing for your child’s educational future.

Personal Exemption Deduction Gets Slashed

Personal exemptions, worth $3,650 per family member, are used to reduce taxable income. However, before the Bush tax cuts, higher income folks lost some or all of these deductions. The Bush tax cuts eliminated this hidden tax increase. But if Congress takes no action, the loss of the personal exexmption deduction will roar back.

Itemized Deductions Get Reduced

Similar to the personal exemption deduction phase out above, the same will apply to itemized deductions to high income earners. Rather than potentially losing all of one’s itemized deductions the rule, if not addressed by Congress, could eliminate up to 80% of certain itemized deductions.

Alternative Minimum Tax to Affect More Middle Income Americans

The AMT (alternative minimum tax), if not adjusted, would impact nearly 28 million people in 2011, up from only 4 million in 2009. This alternate tax was created to ensure the wealthy didn’t get away without paying tax. Now it’s closer to impacting many more middle class Americans unless Congress acts before the end of 2010.

College Savings Plan Get Cut

One popular and tax advantaged way to save for college is through a Coverdell Education Savings Account. Even though the contribution limit was only $2000 (hardly enough to make a dent in tuition), the maximum contribution in 2011 drops to a paltry $500. There are several other college savings plans available, so be sure to check them out before investing for your child’s educational future.

Estate Tax Spikes

The federal estate tax, which in 2010 was zero, is scheduled to return in 2011 for taxable estates over $1 million at a top tax rate of 55%. If you follow such things, you’ll recall that in 2000, the estate tax exemption amount was $675,000.  Congress incrementally increased the exexmption amount over the decade to $3,500,000 in 2009.  While the zero estate tax rate in 2010 was great for estates, it created a lot of bookkeeping headaches and tax liabilities for recipients of the estate’s assets. This is just one more item on Congress’ plate.

Last, and perhaps least impactful, is the elimination of non-prescription OTC (over the counter) medicine from FSAs (Flexible spending accounts) and HRAs (Health reimbursement accounts).

This is a lot of information, to be sure, but with this you can start making wise investment decisions with your various portfolios.

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