Posted on March 20, 2012
Is it déjà vu and will 2012 be a repeat of 2010? It was less than two years ago when the United States Congress, faced with an election year and a pre-mandated reversion of the tax laws to those in place in 2001, “kicked the can” down the road and extended the Bush tax cuts to 2013. In the process of avoiding the politics associated with meaningful tax reform, Congress actually temporarily made more favorable the estate tax laws with the caveat that these also would be subject to the 2013 sunset reversion. Thus, as in 2010, all of the politics associated with tax reform is coming to a head this year, which has the potential to make 2012 a critical tax and financial planning year.
While no one wants to discuss politics, the reality is that taxes are an integral part of the Federal budget and a critical element associated with managing the deficit. Eventually the government’s tax system will change and understanding how it might change is a critical element for personal financial planning. Therefore, while no one knows what the ultimate changes will be, it is important to be aware which aspects of the existing law are being discussed, so as to be best positioned to strategically take advantage of future changes. The window of opportunity may be short, especially, if as in 2010, the changes are not implemented until the very end of the year after the fall elections.
Last month the president proposed a budget that calls for $1.9 trillion in tax increases over ten years coupled with a potential of $375 billion of tax relief measures. Even with this dramatic tax increase, the administration’s planners project the level of the federal debt increasing by $6.7 trillion through 2022. While elements in our Congress have stated that the Budget Bill is “dead in the water” the proposal does highlight what areas are being targeted for change, and thereby providing a starting point when reviewing planning concepts with your advisors.
With the above in mind, the following are some of the proposed budget’s revenue provisions that would potentially impact individuals:
• TAX RATES: The president’s budget includes provisions for increasing and broadening the income tax rate schedules. The current budget proposal includes increasing the top two tax bracket rates to 36% and 39.6% respectively from 33% and 35%. This would in effect reinstate the law in effect prior to 2001. The 36% rate would start at taxable incomes equated to an Adjusted Gross Income (“AGI”) level of $250,000 less the standard deduction and two personal exemptions for a married couple filing jointly and using $200,000 of AGI and one exemption for a single taxpayer.
• DIVIDEND INCOME: Currently most qualified dividends are taxed at 15% or less. Prior proposals have included increasing such dividends to a 20% rate or even to the ordinary income tax rate. The current budget proposal calls for taxpayers subject to tax at the highest two brackets to have dividends taxed at their ordinary tax rate, and at the 15% rate for taxpayers not subject to tax in the top two brackets.
• CAPITAL GAINS: Net long-term capital gains are currently taxed at 15% or less. The current budget provisions increase this rate to 20% for taxpayers in the top two tax brackets.
• ITEMIZED DEDUCTIONS AND EXCLUSIONS: The current budget proposal reinstates the phase out of personal exemptions and the reduction of itemized deductions for higher income taxpayers, defined as taxpayers with yearly incomes above $200,000 or $250,000 for single or joint taxpayers, respectively. In addition, the current proposal would limit the tax value of specific deductions as well as certain income exclusions from AGI and all itemized deductions. This limitation would reduce the value to 28 percent of the specified exclusions and deductions that would otherwise reduce taxable income in the 36 or 39.6 percent tax brackets. Under this Budget provision which is highly controversial, forms of income previously excluded from taxation would now be partially taxed. This would include items such as tax-exempt state and local bond interest, employer paid health benefits, health benefits for the self employed and several other provisions previously excluded from income for those in the highest two income tax brackets.
• THE BUFFETT RULE: The president’s budget proposal includes a complex combination of changes (including those discussed above) that attempt to ensure that taxpayers with over $1 million of taxable income pay at least 30% of their income in income taxes.
• ESTATE AND GIFT TAX: The provisions that will take place if Congress allows the Bush tax cuts to expire would reduce the estate tax exemption to $1,000,000 from the current $5 million level and bring back the estate tax law as was in place in 2001. However, the president’s budget proposal provides for a further change to estate tax laws including a $3.5 million estate tax exemption as existed in 2009, and making permanent the spousal exemption portability that was part of the 2010 law changes. However, the current budget proposal would also change and limit valuation discounts and require longer terms for certain trusts that were common estate reduction techniques. The current budget also has provisions to limit the duration of generation skipping transfers to put limits on states that have allowed transfers into perpetuity.
The above highlights a few of the areas being discussed for future tax changes, but no one knows what will be enacted. The key is to work with your team of advisors to ensure that planning that can be implemented safely and effectively now is done, and that potential opportunistic planning is “teed up” so as to be ready to execute depending on the outcome of the political wrangling.
DISCLAIMER AND DISCLOSURE
Investment objectives are not projections of expected performance or guarantees of anticipated investment results. There can be no assurance that historical investment performance will be achieved in the future. Data provided herein has not been audited or verified by management and is subject to change. Index information is included merely to show the general trends in certain markets in the periods indicated and is not intended to imply that the funds managed by the manager will be similar to the indices in composition or element of risk. The indices are unmanaged, have no expenses and reflect reinvestment of dividends, interest and distributions. Index’s are provided for illustrative purposes only. Telemus Investment Management, LLC does not warrant the accuracy, adequacy, completeness, or timeliness of any information contained herein or derived from third parties. This document is for informational purposes only and should not be distributed.
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