Sweeping tax legislation enacted under George W. Bush is set to expire at the end of 2010. The ramifications for savers and investors are significant, including higher or reinstated taxes across the tax code. Congress has the remainder of 2010 to agree on legislation that would extend some or all of the Bush–era tax cuts, but nothing is certain. Many proposals for partial restatement are already circulating in the House and Senate, however.

If Congress does not act to extend the Bush tax cuts, marginal income tax rates will rise across the board. The highest income tax bracket would rise to 39.6% from 35%. The current 25% tax bracket would revert back to 28%. The existing 28% tax bracket would rise to 31%. And the 33% tax bracket would increase to 36%. Also, the special 10% tax bracket would be eliminated.

Income
(Married filing jointly)
Current If no new legislation
$0–$17,150 10% 15%
$17,151–$58,200 15% 15%
$58,201–$140,600 25% 28%
$140,601–$214,250 28% 31%
$214,251–$232,950 33% 36%
$232,951–$382,650 33% 36%
Over $382,650 35% 39.6%

Proposals on Capitol Hill
In his FY 2011 budget, President Obama proposed to let the current law expire only for the upper–income tax brackets, and to keep the existing tax schedule in place for individuals earning less than $200,000 and couples earning less than $250,000.

Many Republicans, including Senate Republican Leader Mitch McConnell and Senate Minority Whip Jon Kyl, have advocated for extending the tax cuts in their entirety, across all income levels. Some business groups have expressed concern that allowing the tax cuts to expire would also hurt small businesses and discourage hiring.

In July, Senate Finance Committee Chair Max Baucus kicked off the debate on the tax issue with his committee. However, as Congress takes its six-week summer recess, there is speculation that a vote on this issue will not happen until after the mid-term elections, in a lame duck session in the fall. Congress may also vote to merely extend the cuts for another year for all tax brackets until a compromise can be reached.

Dividends and capital gains
The expiration of the Bush–era tax cuts means that taxes on investments would increase. Under current tax provisions, investors pay a 15% tax on dividends and capital gains. If no action is taken to extend current investment tax rates:

  • The tax on dividends would more than double to 39.6% (for investors in the highest tax bracket)
  • The capital gains tax would increase to 20% from 15%

President Obama has proposed that the dividends and capital gains taxes both increase to 20% from the current 15% for high earners, but remain at 15% for individuals earning less than $200,000 and couples earning less than $250,000. Republicans propose to extend all of the tax cuts, with dividends and capital gains taxes remaining at the 15% rate.

Alternative minimum tax
Other issues that could have an impact on rising taxes for investors is whether Congress will enact a “fix” for the alternative minimum tax (AMT).

Introduced in 1969, the AMT was originally designed by Congress to ensure that wealthy individuals could not avoid income taxes by exploiting weaknesses in the tax code. The AMT is a separate, parallel federal income tax system where certain exemptions, deductions, and credits are not allowed. The AMT rules, however, were not indexed for inflation. As a result, an increasing number of middle-class taxpayers have been subject to the tax.

Over the years, to compensate for rising inflation and income levels, Congress has repeatedly approved a patch to raise the income levels that trigger AMT. The patches have provided increases in the AMT exemption annually.

If Congress does not act in 2010, the AMT exemption amounts would revert back to levels that were in place in 2000, and an additional 27 million taxpayers would be affected by the tax next year.*

*Source: Tax Policy Center, The Individual Alternative Minimum Tax: Historical Data and Projections, updated October 2009.

Last year, an exemption was enacted to include couples earning $70,950 and individuals earning $46,700, or less. Congress is again considering an exemption for millions of taxpayers from the AMT, separate from a broader tax overhaul. The details of the proposed patch have not been released.

AMT exemption amounts

Single filers Married/filing jointly
2009 $46,700 $70,950
2010* $33,750 $45,000

*Unless legislative action occurs, the AMT exemption amounts will revert back to year 2000 levels.

For more information, download our white paper, Big tax changes may be on the way, or watch a video Video featuring Bill Cass and Chris Hennessey.