The Wall Street Journal
By: Laura Sanders
December 17, 2010
House passage of a bipartisan tax bill resolves many urgent questions weighing on individuals and businesses--but also creates vast groups of winners and losers among them.
Because the deal left in place many tax rates that otherwise could have jumped significantly, and lowers the payroll tax for all workers by two percentage points, most individual taxpayers should come out ahead, say tax experts.
Yet some bond investors, for example, could be left poorer. Concerns over the deal's long-term fiscal effects have prompted big selloffs in U.S. Treasury securities since the deal was announced on Dec. 6. Moody's Investors Service warned on Monday that the tax deal raises the chance that it would issue a negative outlook on the U.S. government's AAA credit rating.
"It's easy to have lots of winners when you're giving up this much revenue," said Michael Graetz, a former Treasury official who is now a professor at Columbia University Law School. "But we can't finance the government by borrowing forever."
The bill is notable for a couple of things it leaves out. For example, among the big winners are private-equity and hedge-fund executives who prevailed in their battle against "carried interest" provisions that would have taxed their earnings at higher ordinary-income rates rather than as capital gains. Small-business owners, by contrast, lost their push for "1099 relief" that would have eased the requirement to issue Internal Revenue Service forms to vendors receiving $600 or more in a year.
Individual income and payroll taxes. The bill extends through 2012 the Bush-era tax rates enacted in 2001-2003, instead of allowing them to return to pre-2001 levels, effectively preventing a rise for nearly all U.S. taxpayers. Some 15 million lower-income workers now off the tax rolls will not be restored to them, according to the nonpartisan Tax Policy Center.
Affluent taxpayers also benefit from the two-year repeal of the "Pease" limitation (named for the congressman who sponsored it) and personal exemption phase-out (PEP). These are deduction limits that functioned as back-door tax increases for many affluent taxpayers. The Pease provision cut itemized deductions by 3% for incomes above a threshold; PEP eroded the value of the personal exemption.
For 2011 only, the bill imposes a historic reduction in Social Security (FICA) taxes, cutting by two percentage points the employee's portion of the 6.2% tax. Savings per worker will vary with income, but could be as much as $2,136 for those earning more than $106,800, the maximum amount subject to Social Security tax. Both members of a married couple can receive the benefit.
Some see the payroll tax cut as a partial replacement for the Making-Work-Pay income-tax credit of 2009 and 2010, but it benefits a broader range of workers with higher incomes. For 51 million low-income households with married couples earning less than $40,000 ($20,000 for singles), however, the payroll tax cut doesn't make up for the loss of this credit. On average it costs them $210 each, according to Roberton Williams of the Tax Policy Center.
The bill also contains a two-year patch for the "alternative minimum tax" retroactive to January 2010. The AMT, an alternate tax regime originally meant to ensure that people with high incomes pay taxes, isn't indexed for inflation, and has come to include middle-class taxpayers. The patch spares an additional 21 million taxpayers this year.
Investment taxes. The bill extends for two years the current tax rates on long-term capital gains and dividends. The top rate for both will remain at its historic low of 15%. The rate will remain zero for couples with taxable income below $69,000.
According to the Tax Policy Center, more than half of the benefit of this extension will go to people with incomes above $100,000. Absent the extension, the top rate on long-term gains would have risen to 20%, while the top dividend rate could have risen to as high as 39.6%.
Deductions and credits. Among the benefits extended through 2011: deductions for teacher expenses and for state sales taxes in lieu of state income taxes. Lawmakers also extended through 2011 the provision allowing taxpayers over age 70½ to make tax-free donations of IRA assets to qualified charities.
Several education benefits were also extended through 2012. Not renewed was a property-tax deduction for non-itemizers.
Estate and gift taxes. For 2011 and 2012, the top estate-tax rate falls to 35% and the exemption rises to $5 million an individual. Some in Congress had sought a top rate of 45% and $3.5 million exemption.
The bill also allows executors of 2010 estates to elect whether to use 2010 rules or 2011 rules. The choice will help heirs who would pay more as a result of the lapse of the estate tax in 2010 and a corresponding rise in capital-gains taxes.
The new provisions will cut by at least a third the number of estates subject to the tax, which was paid by about 5,500 estates in 2009, according to Tax Policy Center estimates.
Also for the first time, estate, gift and generation-skipping taxes will be "unified" so that one $5 million exemption per individual applies to all three. "This will make it much easier for wealthy taxpayers to make gifts during life to grandchildren," says estate attorney Beth Kaufman of Caplin & Drysdale.
Write to Laura Saunders at firstname.lastname@example.org