Don't Mess With Taxes

And so it begins. At 3 p.m. Eastern time today, Dec. 13, the Senate will vote on the Obama/GOP tax cuts deal.

A key reason for existence of this legislation, officially entitled the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (but for ease of reference, let's just call it The Deal), is that it will take care of tax legislation that will expire on Dec. 31.

So here we are, waiting for some modicum of tax certainty (yes, I realize that "tax certainty" is an oxymoron) with less than three weeks until the end of the year. Yet all of us -- taxpayers, members of Congress and past and future lawmakers -- have known for years, almost a decade in some cases, about the 12/31/2010 drop-dead date.

A friend asked me last week why Congress put off acting? My immediate, flip response was because they can.

Then as I watched the Senate make changes to The Deal that the White House initially said shouldn't/couldn't be altered, I realized there's a holiday connection.

With time short at the end of the year and Senators, Representatives and their staff eager to get out of town to begin holiday celebrations, lawmakers can "decorate" pending legislation just like a Christmas tree.

Who needs earmarks when you can add a sparkling ethanol tax break ornament here or keep that shiny motorsports complex tax break hanging from another section of the law? And where should we place that extension of special rule for marginal wells and rum excise taxes measure for Puerto Rico and the U.S. Virgin Islands? Those are Capitol Hill heirloom legislative ornaments.

But to get the controversial bill through the Senate, such adornments were necessary. And just like holiday shoppers going crazy at the mall with their credit cards, the bill's price tag ended up a bit bigger than expected.

The damage on this gift? $850 billion in tax cuts and spending.

Below are some of the things it bought us.

Individual income tax rates: The big deal about The Deal is that it extends the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent individual income tax rates for two years (through 2012). The rate structure is indexed for inflation.

Deduction, exemption limitations: The Pease limitation on itemized deductions and personal exemption phase-out, or PEP, were designed to reduce the tax benefits of itemizing and personal exemptions for higher-income taxpayers. The limits were phased out under the Bush-era tax law changes and in 2010 there were no limitations.

Under The Deal, both Pease and PEP will be abated for two additional years (through 2012), meaning that, as in the 2010 tax year, higher-income taxpayers will get the full value of all their itemized deductions and personal exemptions for a few more years.

Child tax credit: The $1,000 child tax credit will continue through 2012. The bill also allows the child tax credit to be claimed by alternative minimum tax filers and extends the refundable portion of the credit for two more years.

Other child tax benefits: The adoption tax credit was increase by the Bush tax cuts legislation. It was further expanded under provisions of The Patient Protection and Affordable Care Act of 2010 (aka health care reform) and extended through 2011. The child and dependent care tax credit was enhanced by the Bush tax bills.

Both these tax breaks will continue through 2012.

However, the 2009 enhancements to the adoption tax credit (i.e., the increased credit amount and refundablity) are not part of The Deal.

Marriage penalty relief: To help reduce the marriage penalty, where some couples found they paid more that did two single taxpayers earning the same overall amount, the 15 percent income tax bracket for a married couple filing a joint was increased to twice the size of the tax bracket for an single taxpayers. This tax bracket doubling will continue through 2012.

Earned Income Tax Credit (EITC) simplification: This law provides tax relief for workers who make lower incomes. Current EITC provisions, such as a simplified definition of earned income, a simplified relationship test increases in phase-out limits, will continue through 2012.

American Opportunity Tax Credit: This tax break, created as part of the 2009 stimulus act, is a modifications of the Hope credit. It increased the tax credit for certain higher education costs to $2,500 per eligible student per year. The American Opportunity Tax Credit will be extended through 2012.

Other educational tax benefits: A variety of tax benefits to help pay for education costs were expanded by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the subsequent Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).

For individual taxpayers, key tax breaks include employer provided educational assistance (up to $5,250 excluded from a worker's income), higher income phase-out amounts for taxpayers claiming the student loan interest deduction and expanded Coverdell educations savings account benefits ($2,000 annual contributions and the ability to use the money for some K-through-grade-12 expenses as well as college costs).

All of these will continue through 2012.

Capital gains and qualified dividends: The lower rates (zero percent for taxpayers in the 10 and 15 percent brackets; 15 percent for all other taxpayers) on long-term capital gains and certain dividends will remain in effect through 2012.

Alternative Minimum Tax (AMT): The bill "patches" this parallel tax by increasing the income exemption amount. This means more middle-class taxpayers will not be affected.

For the 2010 tax year, the exclusion amounts are $72,450 for married couples filing a joint return and surviving spouses; $47,450 for single and head of household taxpayers; and $36,225 for husbands and wives filing separate returns.

For 2011, the amounts are $74,450 for joint filing couples; $48,450 for single/head of household filers; and $37,225 for married couples filing separately.

Credit for nonbusiness energy property: This is more popularly known as the energy efficiency home improvement tax credit. Under the original provision, a variety of credits and limits were in place for some common upgrades, such as storm windows and doors and certain heating/AC systems. Those were replaced in the 2009 stimulus bill with a simplified, and larger, tax credit.

The Deal would extend the tax credit through 2011 for certain home energy improvements, but it would do so under the pre-2009 system. This means that the maximum credit would return to $300, not the $1,500 allowed in 2009 and 2010 for certain home energy upgrades.

Extenders: Popular tax breaks such as the above the line deductions of $250 for educators out of pocket expenses and $4,000 for certain tuition and related higher education expenses, the itemized deduction of state sales taxes and tax-free rollovers by individuals age 70½ from IRAs to charitable organizations are continued for the 2010 and 2011 tax years.

Payroll tax holiday: One tax break, the Making Work Pay Credit, would end as scheduled on Dec. 31. But the tax bill would make up for that with a temporary employee payroll tax cut.

As all workers know well, the Federal Insurance Contributions Act, or FICA, mandates that employees and employers each pay a 6.2 percent tax on worker wages of up to a certain amount ($106,800 in 2010 and 2011). This tax amount goes toward Social Security.

For 2011, and that year only, the employee portion of the FICA payroll tax would be reduced 2 percentage points, to 4.2 percent. Employers would continue to pay the full amount for each employee and the Medicare portion, 1.45 percent of income paid by both workers and employers, would continue to be collected.

Estate tax: The estate tax also is covered by the bill. Estates worth less than $5 million would not be taxed. The exclusion amount will be indexed for inflation. Estates valued at more than $5 million (or more depending on future inflation) would be taxed a  maximum estate tax rate is 35 percent.

These provisions would take effect Jan. 1, 2011, and will be in effect through 2012.

For those who die in 2010 while there is no estate tax on the books, executors of such estates have the choice of applying the 2010 law to the estate or using the 2011-2012 estate tax law, which includes stepped-up basis rules.

The stepped-up basis option would permit heirs to value assets they receive at their fair market value on the date of the original owner's death. If the 2010 no-estate-tax law is used, then the heirs also inherit the decedent's basis in the asset.

But wait, there's more! There's more, lots more. Feel free to flip through the bill itself, the Congressional Budget Office's look at the costs and/or the Joint Committee on Taxation explanation of the provisions.

If the bill does make it through the Senate, it will head to the House where its prospects are even iffier.

Although that chamber is still in Democratic control, many in the Party are angry with Obama for agreeing to The Deal.

So here we are, waiting for some modicum of tax certainty (yes, I realize that "tax certainty" is an oxymoron) with less than three weeks until the end of the year.

Related posts:

• Obama, GOP strike deal to extend tax cuts
• Reaction to proposed tax deal mixed (vote in the poll!)
• Democrats agree to disagree on tax deal
• House approves extension of middle-class tax cuts in symbolic vote
• Tax cuts task force to hammer out deal
• IRS commissioner chides Congress for its delay
  in dealing with expired taxes

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