Top 8 Tax Changes for 2013

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Congress is gone on recess and a whole nation is trying to figure out whether Twitter is going to predict the outcome of the presidential election. Meanwhile, President Obama and GOP frontrunner Mitt Romney are bashing each others’ tax plans like there’s no tomorrow, which isn’t too far off considering the amount of debt we’ve managed to rack up since the turn of the century. For the rest of us at home, there’s one question that everyone is thinking about, regardless of economic status and regardless of who we’re going to vote for: What is going to happen with our taxes in 2013? 

All in all, there are eight really big tax items that need to be considered as congress leaves for recess and we rapidly approach this year’s presidential election:

1. The Bush-Era Tax Cuts

2. The Payroll Tax Cut

3.Estate Tax

4. Investment Income Tax

5. Alternative Minimum Tax

6. Corporate Income Tax

7. Healthcare Reform Tax

8. Personal Deductions

 In this article we’ll go through each and every item, explaining how each candidate approaches the issue (or doesn’t) and then assessing the most viable solution from each of the candidates proposals. 

#1: The Bush-Era Tax Cuts

Situation: First and foremost, the 2001/2003 Bush-era tax cuts are on the chopping block. Letting the Bush-era tax cuts expire like they’re scheduled to do will bring our income brackets back to pre-2001 levels. As an example of how this would impact a typical American household, a married couple filing jointly who has no other tax deductions or credits other than the standard deduction of $11,900 who bring in $71,900 annually will pay about three thousand dollars more in taxes each year.

Proposals: 

Assessment: Fewer than 3% of all IRS returns reported an AGI (adjusted gross income) greater than $200,000, meaning that the middle class objections to abolishing the Bush-era tax cuts – while warranted in the fact that no one wants to pay more taxes – are more of a psychological problem than an economic one. In 2012, the standard deduction for married couples filing jointly is $11,900. If tax rates returned to 2000 levels, you could make up to $55,749 and be taxed only at the 15% rate (so your total income tax after taking a standard deduction and filing jointly with your spouse would be $6577.35 – this makes your effective tax rate only 11.79%).

A permanent extension to the Bush-era tax cuts is all-around a harmful solution to anyone who isn’t part of the top 5%. Even if we somehow convinced the middle class that these tax cuts will help them (cognitive dissonance has worked before), in the long run our economy and our federal deficit will suffer greatly. The good news is that even if we roll back to pre-2001 rates, our top tax rate is still less than it has been historically when our country is at war and broke. 

If the government purse isn’t filled with income taxes then one of two things has to happen in order to offset spending: either we cut federal spending (which means we cut federal programs like HeadStart and Medicare), or we raise taxes elsewhere. You can’t have low taxes and expect to fund America after we’ve been at war for over a decade. 

#2: The Payroll Tax Cut

Situation: During the recession, Congress voted to lower the witholding rate from 6.2 percent to 4.2 percent. This temporary rate cut was never supposed to be permanent as it was seen as a necessary solution to a dwindling consumer spending problem (which is what happens during a recession). 

Proposals: Neither candidate has proposed an additional extension or revision.

Assessment: All due diligence points to an obvious and necessary fact: the payroll tax cut will expire and the witholding rate will return to its pre-recession level of 6.2 percent. According to the Congressional Budget Office (CBO), this change will bring in an additional $95 billion in tax revenues next year.  While it’s disheartening to see the middle class having to suffer the brunt of the economic challenges our country has faced over these past couple years, the effect on middle-class paychecks will be noticeable but not crippling:

 

One concern is that a return to pre-2000 tax levels accompanied with this increase in witholding will create enough of an effect on an already struggling middle class to sway their vote in a direction that is normally opposite of where they would like to go. Unfortunately, social issues end up taking a back seat when it comes to putting food on the table, and in the end I think people are going to vote for a candidate that lets them keep more of the dwindling compensation they get from their under-valued labor.Whether this means they’ll side with President Obama this election or not, once April of 2013 comes around, enough people are going to be upset about their tax returns to ensure that if a third term was possible, President Obama wouldn’t stand a chance. 

#3: Estate Tax

Situation: Many Americans have no idea what the federal estate tax is for. According to U.S. tax law, a tax is charged on the transfer of all the money you have to your beneficiaries or heirs. This mean when you die, your kids – or whoever you decided to name as your beneficiary in your will – taxes will be owed on the estate being transferred. Some people think this is outrageous, but fear not: in 2012, taxes are only charged on the transfer of estates larger than $5 million, and only on the amount over $5 million at a rate of 35 percent. 

Proposals:

Assessment: Estate taxes are important to perpetuating and passing down wealth from generation to generation. Parents who want to leave the fruits of their hard-earned money to their children should pay close attention to what is going to happen when either candidate is elected. If nothing is enacted, estate taxes will revert back to their pre-2001 levels. This means that only the first $1 million is exempt, and the tax beyond $1 million is a whopping 55%. While Mitt Romney’s plan to abolish the tax altogether is great for recipients, some sociologically charged minds might contend that the inheritance taxes are necessary to make up for the gaps in other tax incomes, as well as help to ensure that people aren’t just getting large lumps of money and then enjoying the perks of America without having to pay their fair share (one in four beneficiaries of an inheritance permanently leave America’s workforce). 

So whether you’re a democrat or republican, if you believe that taxes are a necessary burden that we must impose on our citizens then you’ll want to support President Obama’s plan, which will increase the amount of taxable inheritance for future transactions, is still much, much lower than where they would be if rates returned to pre-2001 levels.

Update: I received an email from a friend telling me that ‘no one in their right mind would ever support a tax on their inheritance so obviously anyone affected by this (anyone who would receive an inheritance in the future) will vote for Romney.’ While this may be the case, unless we all are willing to pay our share of taxes and help provide to the government what it will in turn provide to its citizens, what then is our way of knowing that we have contributed to the betterment of our country and have solidified our stake as citizens in a country that we are proud to be a part of?

#4: Investment Income

Situation: Capital gains (or “investment income”) are the differences between the sale price and the purchase price of assets like stocks, including the amount of dividends a stock pays. The tax computation for these types of income are mind-numbing but not completely obfuscated. Basically, short-term capital gains – which occur when you buy and then sell an asset in less than a year – are taxed at your marginal tax rate, and long-term capital gains – which occur when you buy and hold for longer than a year – are taxed at a flat rate of 15% unless your adjusted gross income has you falling in the ten or fifteen percent tax brackets (in which case, you pay zero capital gains tax). In addition to taxes on the sale of stocks, investors are also taxed on their dividends – a cash disbursement made to the shareholders of a company – at a flat rate of 15% if the asset is held longer than 121 days, or if held for a shorter period, at the same rate as their adjusted gross income. 

Proposals: 

Assessment: Both candidates are bringing some viable solutions to the table. President Obama understands that we need to increase taxes across the board in order to offset the treacherous habit of spending on credit that America has succumbed to since the Global War on Terrorism started. Mitt Romney, on the other hand, doesn’t want to touch investment income taxes for the top 3%  of filers, and wants to get rid of investment income tax for about 97% of the country (these numbers are based off of 2009 IRS reports of the number of tax returns reporting AGI > $200k). 

President Obama’s plan is on the right track. In order to combat the curtailment of ordinary income brackets, investors often put their money into attractively-yielding investments and only have to pay 15% taxes in dividend income. This is true even for giant holding companies who manage multi-billion dollar portfolios. Companies like this will pull in well over $100 million in dividend payouts annually and only be required to pay 15% in taxes, whereas if the profits were reported as ordinary income they would be taxed according to the corporate tax rate. The same holds true for wealthy individual investors who would rather pay 15% taxes on their dividends than 39.6% taxes on income (and could blame them?).

[Are you being fooled by the corporate tax rate?]

Mitt Romney’s plan recognizes the burden this will place on wealthy investors. By treating all capital gains as ordinary income, people who are retired off of their dividend-earning portfolios might have to adjust their positions around because instead of their dividends being taxed at the 15% rate they will now be added to their Adjusted Gross Income and taxed according to their marginal tax rate. Additionally, taxes from long-term positions that are sold off will now be subject to an additional 5% tax (for a total of 20%) – unless your adjusted gross income puts you in the 15 percent bracket, in which case your long-term capital gains tax will be 10%. 

Something else to consider is that the Affordable Care Act calls for an additional 3.8% Medicare tax on all capital gains starting in 2013. Unless Mitt Romney is elected and manages to repeal the Affordable Care Act (and stop the mass protests that would ensue), this will be a definite thing. 

#5: Alternative Minimum Tax

Situation: In 1962 Congress enacted a Minimum Tax in order to generate tax revenue from everyone benefiting from tax deductible incomes. The present system, called the Alternative Minimum Tax (AMT), was enacted in 1982 and serves much of the same function (and still is not adjusted for inflation, but that’s another story). In a nutshell, if your federal taxes owed are less than the AMT, then you would pay the difference between the two. This really only affects businesses with gross receipts greater than $7.5 million, as smaller corporations are exempt from AMT. So even after you plan on giving away a bunch of money to charity, deducting and amortizing expenses left and right, and then contributing to your employee health care plan, your corporation is still required to pay a minimum tax to the federal government. 

Proposals: 

Assessment: The Alternative Minimum Tax is a necessary (and frustrating) tax that is there to ensure that we don’t try to take advantage of the system. Any one of us can plan out an entire year’s worth of tax-deductible strategies that would lower our taxable income to nearly zero, and the AMT was created specifically because of that. While it’s great that we are allowed to deduct expenses from our taxes, there is without a doubt an absolute necessity to collect taxes in order to keep this country running. 

The above graphic comes from the Center on Budget and Policy Priorities, in an article dispelling some common myths about the AMT. One of the biggest ones that the GOP tends to talk about is that the AMT is becoming a middle-class tax. But this is just not true. Doing away with the AMT would drastically benefit high-income Americans and corporations and do nothing but add more of a future budgetary burden on middle and low income Americans.

President Obama wants to adjust the AMT for inflation, and Mitt Romney wants to do away with it altogether. I’m always a fan of paying less taxes, but unless Republicans are going to put forward a plan to generate those lost hundreds of billions of dollars in tax revenue from the AMT – and not by cutting social and government aide programs – then the AMT is going to be here to stay. 

#6: Corporate Income Taxes 

Situation: The United States corporate tax rate is one of the highest in the industrialized world. While some claim that such a high tax rate discourages business growth and expansion into America, others point to outsourcing and profiteering as the real reason why corporations are leaving. Nevertheless, the corporate tax rate caps out at 35% for all income above $18.33 million, and both the left and the right understand that a lower corporate tax rate to compete with global demands is necessary (even if it means sacrificing corporate tax revenues). 

Proposals: 

 

Assessment: Corporate tax revenue as a percent of GDP is the lowest its ever been in history. This fact is doubled in importance because we are also in the longest war of our country’s history. During WWII, the highest-income earners paid taxes at a top rate of 91%. At that time, everyone understood that America was at war, taxes were needed to fund the war, and that people needed to pay taxes if they weren’t going to go off to fight. Today the climate is much different. While people complain about the high corporate tax rates, everyone seems to forget about the real numbers that matter: how much are we actually collecting from high-income earners? 

Over ten years of war, a housing bubble nightmare, Wall Street bailouts, and an economic recession later, social programs are being cut and corporate income taxes are generating the lowest amount of tax revenue since the last time we were engaged in a war (that lasted less than half as long!). The middle class predominantly supports President Obama because he wants to tax high-income earners to start paying their fair share; if the middle class is going to go off to fight and die, the least the wealthy can do is pay some more taxes. On the other hand, Republicans are convinced that higher corporate taxes will equate to less “job growth,” which is a fancy term for “bloated salaries.” 

#7: Healthcare Reform Tax

Situation: With the signing of the Affordable Care Act, a healthcare tax is being imposed on wages and investment income. Starting in 2013, all wages will incur a 0.9% healthcare tax, and all investment income will incur a 3.8% Medicare tax. 

Proposals: 

Assessment: The additional taxes on wages is a necessary step to pay for the enormous benefits of the Affordable Care Act. Mitt Romney’s dissatisfaction with the additional payroll taxes (which I believe is only a tactic to appeal to people who are generally upset about more taxes) has not produced a viable solution to the Affordable Care Act other than repealing it as per Paul Ryan’s budget. The additional wage tax is going to infuriate a lot of Democrats, although I’m not confident that it will upset them to the point of changing sides and aligning with Romney. An additional wage tax in order to offset the expenses of the healthcare industry, coupled with terrible health insurance premiums that already plague Americans, seems to be the start of a downward spiral of the Democrats catering to Republican efforts to keep the for-profit health industry alive. This political strategy to induce bipartisanship on legislation that helps the majority of Americans but adds financial burden to them at the same time seems like a slap in the face: If we’re going to add a wage tax, why not go all-out and slap on an additional 20% wage tax and create a free healthcare system? In the end more Americans would agree with higher taxes if our healthcare wasn’t so expensive. 

#8: Personal Deductions

Situation: In further efforts to combat tax loopholes, personal deductions limitations have been imposed and continue to be imposed. As we approach FY13, one of the biggest challenges for our political leaders is to create a fair and balanced budget. While personal deductions reform may seem pointless for Americans who always claim the standard exemption on their 1040, tightening up loopholes in corporate deductions and tax rates means we also have to start cracking down on personal deductions. 

Proposals:

Assessment: Only about 3% of Americans are bringing in the kind of greenbacks that would encourage them to start claiming crazy amounts of deductions in order to limit their taxable income, so for the majority of America who use the standard exemption this will have no effect. Mitt Romney did muster up the courage to admit that there are tax loopholes out there that exist and that he wants to close them, but hasn’t addressed how he would (other than by offsetting the lost tax revenue from lowering tax rates by cutting government programs). President Obama would like to limit personal deductions to 28%, which seems like a good idea until you’re trying to write off both your mortgage interest on your new beachfront property and the dressage costs for your prize-winning horses. 

 

Going Forward

Out of all of the tax changes and proposals, the healthcare tax is one that I’m not happy with paying. An additional wage tax would make sense if we moved to a more socialized system of medicine, one in which we didn’t have to worry about insurance and copays and could receive medical attention because we’re tax-paying citizens. We spend so much money on healthcare already, and that’s just at the government level. Instead of tippy-toeing around becoming a country that’s really concerned with its people, why don’t we take a full plunge and charge a higher income tax and offer free healthcare for everyone?

Obviously this is impossible because of the huge hit to the healthcare industry’s profits, even though the average American would actually be paying less considering that they wouldn’t have to carry health insurance. However, higher taxes on all income (much higher than President Obama is proposing that we return to) would help to offset an increasingly insolvent budget whose mistakes and shortcomings keep following us year after year. Eventually we’ll have to realize that even though we want to blame healthcare for our national debt, the reality is that defense spending has spiraled out of control behind the curtains drawn over the eyes of a scared public. Healthcare and education are human capital investments and should take up most of our spending, not defense. This terrible habit of paying for tanks with Grandma’s Medicare will catch up to us, and when we have to pay the piper I’m afraid that my generation will be long gone and it will be my daughter’s children who suffer the brunt of the mistakes of our Nation’s babyboomers.