By Sandra Block USA TODAY
This year, though, even veteran advisers are unable to offer much more than a shoulder to cry on.
Barring congressional action, the broad tax cuts adopted during the George W. Bush administration will expire at the end of the year, with the top income tax rate rising to 39.6%. Taxes on capital gains and dividends will also increase, the alternative minimum tax will spread like kudzu, and taxes on estates will soar. The marriage penalty will return, a lucrative tax credit for parents will be cut in half, and the payroll tax withheld from workers’ paychecks will rise to 6.2% from 4.2%.
Any resolution to head off this battery of tax increases is unlikely to come until after the November presidential election. In the meantime, taxpayers are paralyzed, tax preparers and financial planners say.
Tax uncertainty “is holding back a lot of business investment,” says William McBride, economist for the Tax Foundation, a non-profit that supports lower taxes. “Everyone, left, right and center, agrees that this is very damaging for businesses and individuals in their economic decision making.”
Tiffany Washington, owner of Washington Accounting Services in Waldorf, Md., says the standoff about extending the payroll tax cut caused her to put off hiring another employee.
In December, Congress passed a two-month extension of the payroll tax cut, which added about $40 to the average worker’s paycheck. Washington says she was concerned that a drop in take-home pay at the end of the two-month period could lead the new employee to leave for a higher-paying job.
In February, Congress agreed to extend the tax cut through 2012. By that time, Washington says, it was too late to train someone for the 2012 tax season.
One of Washington’s three employees recently had to take a leave of absence for medical reasons, leaving her short-handed. That has forced Washington, who has owned the business for five years, to work 70 to 80 hours a week during tax season.
Washington has the advantage of knowing her way around the tax code. That’s not the case with many self-employed and small-business owners who can’t afford a chief financial officer to help them navigate the constantly changing tax laws, says Kristie Arslan, chief executive officer of the National Association for the Self-Employed.
With the tax code constantly in flux, she adds, “they don’t know how to plan or what to do.”
How tax uncertainty is affecting different groups of taxpayers:
Currently, tax rates for ordinary taxable income range from 10% to 35%. If the Bush tax cuts expire, those rates will rise to 15% to 39.6%.
President Obama has proposed making the Bush tax cuts permanent for taxpayers with income of less than $200,000 ($250,000 for married couples). Congressional Republicans, who currently control the House, favor extending all the Bush tax cuts. The leading contenders in the Republican presidential primary favor reducing current tax rates on income.
Rates aren’t the only wild card facing families, though. Other tax issues that are unresolved include:
•The alternative minimum tax. The AMT, a parallel tax system that eliminates many popular deductions and credits, was originally designed to prevent high-income taxpayers from avoiding taxes. Because the tax was never indexed to inflation, the number of taxpayers forced to pay the tax has steadily grown.
Since 2001, Congress has prevented a jump in taxpayers subject to the AMT by adopting a temporary stopgap measure — known as a patch — every year. The current patch protects most taxpayers from paying the AMT on their 2011 taxes but doesn’t extend into 2012. Without an extension, more than 31 million taxpayers will owe an average of $4,200 in additional taxes this year, according to the Tax Policy Center.
•Tax extenders. In recent years, Congress has adopted a panoply of temporary tax deductions and credits targeted at homeowners, parents of college students, seniors and others. Lawmakers typically extend these tax breaks, but there’s no guarantee it will happen this year.
According to H&R Block, 71 tax provisions, including deductions for college tuition, private mortgage insurance premiums and state sales taxes, expired on Dec. 31, 2011, and have yet to be renewed.
Tax provisions scheduled to disappear on Dec. 31, 2012, include the American Opportunity Tax Credit, which provides a credit of up to $2,500 per student for qualified college costs, a tax exclusion for forgiven mortgage debt, and a tax credit for employer-provided child care.
Unless Congress acts before Dec. 31, the maximum rate for long-term capital gains will rise to 20% from 15%. Stock dividends, currently taxed at a maximum of 15%, will be taxed as ordinary income, with a top tax rate of 39.6%.
Obama’s 2013 budget proposes raising taxes on dividends to a maximum of 39.6% for the wealthiest investors. Wealthy investors would also pay a maximum of 20% on long-term capital gains. Most Republicans support extending the current rates on capital gains and dividends.
With the debate unlikely to be settled until after the election, some investors could feel compelled to sell toward the end of the year to lock in profits at historically low tax rates, analysts say.
An increase in taxes on capital gains and dividends won’t affect the millions of investors who save in 401(k)s and other tax-deferred retirement plans, but it would affect those with taxable portfolios. “December could be a very ugly time for the stock market,” McBride says.
Ordinarily, financial advisers recommend against allowing taxes to drive investment decisions, says Richard Kaplan, law professor at the University of Illinois College of Law. This year could be different, he says. “Fifteen percent is about as good as it’s going to get,” he says. “The only real question is how much higher it will be next year.”
The desire to sell before tax rates rise won’t be limited to stocks and mutual funds, says Lonnie Gary, an enrolled agent in Mountain View, Calif. Some of his clients have owned their homes for many years and could owe taxes when they sell, even with the $250,000 ($500,000 for married couples) capital gains exclusion for primary homes.
Mitchell Adel, an elder law attorney with Cooper Adel in Centerburg, Ohio, works with several farm families who are, he says, “asset rich and cash poor.” This year, planning their estates is a lot more complicated than figuring out which crops to plant.
The estate tax exemption is scheduled to shrink from $5 million to $1 million on Dec. 31. Inherited assets that exceed that amount will be taxed at a maximum rate of 55%, with a 5% surcharge on estates that exceed $10 million.
Obama has proposed returning to the law that was in place in 2009, with a $3.5 million exemption and a top tax rate of 45%. Other proposals pending in Congress would extend the current exemption or repeal estate taxes entirely.
Because there are broad philosophical differences between lawmakers on how estates should be taxed, uncertainty about this tax is perhaps even greater than questions about future income tax rates, according to an analysis by accounting firm KPMG.
That makes it difficult for farmers and other family-owned businesses to develop an estate plan, Adel says.
Some families, concerned that estate taxes will rise, will take advantage of the current $5 million gift tax exemption to shift assets to their children, which isn’t always a wise move, he says. Parents may later regret giving up control of the business, and the children could face capital gains taxes when they sell, he says.
Uncertainty about future estate taxes also gives people who are uncomfortable with estate planning an excuse to procrastinate, says Forrest Williams, a financial planner in Virginia Beach.
“I think people are already in paralysis to some degree because they have to think about their own mortality and have to answer a lot of tough questions,” he says. “This is giving them another excuse not to deal with it.”
That can lead to catastrophic results, Williams says. Numerous family-owned businesses have been forced to close after the owner died without an estate plan, he says.
Williams says families can work with whatever exemption Congress comes up with, as long as it’s for the long term. Temporary extensions give “nobody an opportunity to plan,” he says.
Still, there’s a good chance Congress will vote for another temporary extension at the end of the year, says Clint Stretch, tax principal for Deloitte Tax in Washington, D.C. Extending the tax cuts through 2013 would give lawmakers time to embark on a serious debate about reforming the tax code.
Tax analysts generally agree that Congress can’t maintain current tax rates and prevent the AMT from spreading without reducing or eliminating some popular tax breaks.
“We’re talking about a five- or six-week legislative session between the week after the election and Christmas,” Stretch says. “That’s a very short time to try to come to a fundamental agreement on something we’ve been arguing about for 12 years.”