The Leading Edge - Fall 2010 - PKF - 14

FINANCE

Time to plan strategy for ‘sunsetting’ tax cuts
By Dennis Seeds

I

t’s being called the largest tax increase in American history by some critics, and it’s posed to hit all taxpayers on Jan. 1, 2011 unless Congress takes action. It’s the sunset of the President Bush tax cuts of 2001 and 2003. Many tax breaks were afforded by the legislation, including reductions in federal income tax rates, dividend tax rates and the capital gains tax. Cuts were made in estate and gift taxes and the earned income tax credit was expanded. In short, when the cuts expire, sweeping changes are expected. “Even the most seasoned tax professionals are likely challenged to maneuver through the myriad of provisions scheduled to sunset as of Dec. 31,” says David Shuman, managing director, Kahn, Litwin, Renza & Co. Ltd., a Leading Edge Alliance firm.

Here’s the focal point
Drawing high concern are tax rates on income, long-term capital gains and gifts. “The centerpiece of the Bush tax cuts, still being enjoyed by taxpayers, were reductions in marginal tax rates on ordinary income and a maximum preferential tax rate of 15 percent on long-term capital gains and so-called qualified dividends,” Shuman notes.

If the tax cuts are allowed to expire, the maximum tax rate on ordinary income will return to 39.6 percent from 35. The maximum rate on capital gains would increase to 20 percent from 15 (with an 18 percent rate for capital assets held more than five years). Most all other tax brackets would see an increase of 3 to 4.6 percent. “A real sleeper is the treatment of qualified dividends that will no longer be taxed at the top rate of 15 percent,” says Dennis O’Brien, partner in charge of tax services at Sikich LLP, a Leading Edge Alliance firm. “A high bracket taxpayer with significant qualified dividend income will see a very significant increase in overall income tax.” O’Brien gives this example: Imagine a retiree who largely lives off stock or mutual fund investments and earns $100,000 per year in qualified dividends. Assume that this taxpayer is in the 25 percent bracket. The taxpayer would pay an additional $10,000 in federal income tax ($100,000 x (0.25-0.15)) on the dividends alone—substantially more than the 3.4 to 4.6 percent rate increases mentioned above. For wealthy clients, the scheduled upward momentum in the marginal rates is the top concern, Shuman says.

“Besides tax rate increases, the phase-out of itemized deductions for high income taxpayers returns to 3 percent of adjusted gross income—up from 0 percent in 2010,” says Douglas D. Mueller, partner at Anders Minkler & Diehl, a Leading Edge Alliance firm. This will effectively increase taxpayers’ federal liability by as much as 1.19 percent, he explains. “Other items to note include the return of the ‘marriage penalty’ at the lower end of the tax brackets, the end of the 10 percent tax bracket and the continued annual guessing game for the alternative minimum tax (AMT) exemptions,” Mueller adds.

Silver lining
Accountants point out that several measures can be taken to contend with the changes. Proper planning should be done to determine if acceleration of capital gains into 2010 is a good idea, O’Brien says. “On the surface, most taxpayers would save 5 percent on capital gains by accelerating the gains into 2010,” he explains. “However, Alternative Minimum Tax, various phase-outs, anticipated changes in income or deductions, time value of money factors and other circumstances should all be considered.”

14

VOLUME 11 • ISSUE 1 • FALL 2010
The Leading Edge - Fall 2010 - PKF

Table of Contents for the Digital Edition of The Leading Edge - Fall 2010 - PKF
