Tax planning for individuals is always a challenge for CPAs and their clients, but for the past couple of years and in the foreseeable future it seems even especially so. Much of a person’s tax picture can’t truly be known until Congress extends or fills some components of the tax law. That invariably occurs in December of each year, just in time to file. So much for being able to really know what tax law will really apply in order to plan! Even with that said and even though it seems that most taxpayers are focused on 2009 tax information to prepare their income tax forms, there should be as much effort on tax planning for 2011 and beyond due to upcoming provisions and the Administration’s newly released budget proposal for 2011.
While 2010 will be very reflective of 2009 rules, the 2011 year will prove to be dramatically different due to sunset provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) scheduled to go into effect for 2011. The newly released Fiscal Year 2011 budget proposal includes quite few revenue raising proposals which either scrap the EGTRRA sunset rules or change them significantly. To help provide a framework of what you may be hearing or reading about in the future, we hope to shed some light on current law, the sunset provisions, and the President’s recently proposed budget for 2011 in the income tax arena. In the area of tax rates, under current tax rules, the first tier of taxable income is taxed at 10% and the second at 15%. The size of the 15% tax bracket for married taxpayers filing joint returns is twice the 15% tax bracket for individual filers. The top four tax brackets are 25%, 28%, 33%, and 35%. By all accounts, tax rates in the past couple years are at an all time low although I am sure it doesn’t seem so when it comes to paying Uncle Sam.
Beginning in 2011, under current regulations due to the sunset rule, there will be no 10% rate and the first tier of taxable income will be taxed at 15%. The size of the 15% tax bracket for married taxpayers filing joint returns will be reduced to 167% of the 15% tax bracket for individual filers (instead of 200%) and the top four brackets will be 28%, 31%, 36%, and 39.6%. However, the recently released budget proposal for 2011 would allow the first four taxable income brackets to remain at 10%, 15%, 25% and 28%. The 33% bracket would rise to 36% and the 35% bracket would rise to 39.6%. The 36% rate would apply to an approximate taxable income of $231,000 for married taxpayers filing jointly with no other dependents and $190,000 for single filers with no dependents. The 39.6% rate would apply to approximate taxable income of $373,000 for married taxpayers filing jointly, heads of household and single filers (all considering no additional dependents).
One question we get asked frequently pertains to capital gains and dividends. This area is of particular interest to investors and retirees who own stock portfolios that have been able to continue paying dividends in this down economy. Currently, most long-term capital gains (items owned for more than one year) are taxed at a maximum rate of 15%.
One of the best tax savers in this area and sure to be changed is the current provision where if the long-term capital gain would be taxed at a rate below 25% if it were ordinary income, it is taxed at a zero percent rate. This provision was first effective for taxable year ending 2008. Qualified dividends (dividends from qualified US stock investments) are also taxed under these same provisions. This has been one of the best tax savers for investors and retirees with investments in history. Beginning in 2011, unless changes are made, long-term capital gains will be taxed at 20%. The qualified dividend provision will go away and all dividends would be subject to ordinary income rates as they were many years ago. For individuals with heavy stock investments that are continuing to pay dividends, this will result in a hefty tax increase.
The 2011 budget proposal also calls for a 20% tax rate on long-term capital gains and qualified dividends but only for married taxpayers filing jointly with approximate taxable income over $231,000 with no other dependents and for single taxpayers with approximate taxable income over $190,000 with no other dependents. All other taxpayers would be subject to the current rules in place now either paying no tax or 15% on long-term capital gains and qualified dividends as described above. As is true with all tax legislation and budget proposals, the above will likely change several times before final passing of any proposal or legislation. So I wouldn’t hang my hat on any particular item or number, but hopefully this summarizes the current thoughts and leanings on Capitol Hill.