Here’s a look at the laws that could wage a multipronged attack on your wallet and what you can do to prepare.
Over the last few years, Americans have observed a series of tense Capitol Hill confrontations over what to do about expiring tax code provisions. While each was significant, their scale is dwarfed by what looms at the end of this year: Without action by Congress, Americans face a half-trillion-dollar tax hike in 2013, according to the Tax Foundation — a scenario so ominous that pundits have nicknamed it “taxmageddon.”
While the outcome is anyone’s guess, it’s important to know what hangs in the balance and what it could mean for your bottom line.
|What’s at Stake||What Will Happen Jan. 1 Without Federal Action|
|Income Tax Brackets||Rates would rise for all Americans, with the lowest bracket rising from 10% to 15% and the highest from 35% to 39.6%.|
|Dividends||Would be taxed at the same rate as ordinary income —
instead of today’s 15% maximum rate.
|Capital Gains||Maximum rate would rise to 20% from the current 15%.|
|Personal Exemptions and Itemized Deductions||Would be reduced for high-income taxpayers.|
|Alternative Minimum Tax||Without extension of temporary exemptions, more taxpayers will be snared by this parallel tax system.|
|Payroll Taxes||Individuals’ share of Social Security taxes would return from the temporary 4.2% to the normal 6.2%; the self-employment tax rate would rise from 10.4% to 12.4%.|
|Estate Taxes||Maximum estate tax rate would rise to 55% from the current 35%; estates valued at more than $1 million would face the tax (versus the current $5 million).|
|Education Savings||The annual contribution limit for Coverdell Education Savings Accounts would fall from $2,000 to $500 and qualified withdrawals would no longer be permitted for K-12 expenses.|
|Child Tax Credit||Falls from $1,000 to $500.|
|Married Couples Filing
|The expiration of features meant to address a so-called “marriage penalty” would reduce standard deductions and push many couples into higher tax brackets.|
|Maximum credit would fall from $13,360 to $6,000 and would only be available for special needs children.|
|Other Popular Tax Breaks
|Deductions for state and local sales taxes, higher education and teachers’ classroom supplies all would vanish.|
An Uncertain Outcome
Adding to the pressure, members of Congress will grapple with these broad-reaching tax expirations while facing national elections and a related showdown over what they should do when the nation again reaches its debt ceiling. That is the amount of debt the federal government is authorized to have.
Don’t expect a clear outcome anytime soon. “Frankly, it’s unlikely that it will be resolved before the November 6 election,” says Dan Brouillette, USAA senior vice president for government and industry relations.
A bipartisan group of senators has begun working in hope of having a package ready shortly after the election, Brouillette says. “However, their final product could depend on the election results.”
As with many recent tax issues, the nation may get a short-term extension that preserves our current tax rules for a few months or a year or two. On the other hand, the resolution could come in the form of sweeping tax reform that stretches to other tax provisions that aren’t set to expire.
Personal Tax Moves: Watch and Wait
Given all the uncertainty, what should USAA members do? J.J. Montanaro, a CERTIFIED FINANCIAL PLANNER™ professional at USAA, offers three pointers:
- Don’t make big bets. “Since the outcome is unpredictable, I wouldn’t make any big financial decisions based on an assumption that the tax debate will end one way or another,” Montanaro says.
- Tighten your budget. “If your taxes do increase, you’ll be better prepared. If they don’t, you’ll have a windfall to dedicate to other goals,” he says.
- Stay alert. “Once the outcome is known, you may find it will be to your advantage to make some financial moves this year — under the current tax law,” Montanaro says. For example, if you face higher capital-gains rates in 2013, it may be better to sell some of your investments sooner rather than later.
If recent experience is any guide, Congress may not act until late December. That means you may have limited time for those late-year decisions. Until then, keep monitoring for timely updates.