Taxmageddon – 1/1/2013: Pending Increases in Income Tax Rates

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As we approach the fall election, one of the most discussed topics is Taxmageddon: the pending, significant increases in individual income tax rates despite a weak — and apparently weakening — economy. If Congress fails to act, and there is no expectation that it will do so prior to the election, U.S. federal income tax rates will automatically increase on January 1, 2013. While the Administration seeks an extension of the “Bush Tax Cuts” for those earning less than $250,000 and Republicans press for an extension for all taxpayers, it is possible and perhaps probable in the current political climate that there will be no extension for any taxpayers. Indeed, some Democrats have advocated for this outcome unless Republicans agree for the more modest extension of the tax cuts, especially in view of the widening budget deficit. There is also the possibility that there will be no tax act in 2012 and then a retroactive tax decrease for some taxpayers next year.

Linked here is a detailed presentation on the expected increase in tax rates. In summary, the maximum federal long-term capital gain rate will increase from 15% to 23.8%, including a new 3.8% “healthcare tax” on interest, dividends, capital gains, and other passive income realized by “high earners.” The Supreme Court recently upheld the tax as part of its decision on the healthcare act and the tax would apply to individuals earning more than $200,000 per year ($250,000 in aggregate for married taxpayers). The maximum tax rate on passive, ordinary income, such as interest and dividends, would increase from 35% to 43.4%, including the healthcare tax. The new 3.8% tax also would apply to wages of these earners, increasing the current “Medicare” tax borne by individuals from 2.9% to 3.8%. In this connection, the “employee portion” of the tax would increase from 1.45% to 2.35%. The “employer portion” would remain the same at 1.45%.

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