Tax Uncertainty Has Chilling Effect for Businesses and Individuals

Tax season is just over. The filing deadline of April 17 is past. (My son, as a little kid, said he thought there were five seasons – spring, summer, fall, winter and tax season.) As soon as you have calculated the damages for your 2011 Form 1040, the next question for most taxpayers is what can be done to reduce taxes in the future?

Tough question. At the end of this year, the Bush tax cuts expire. The Bush cuts were to expire at the end of 2010. During the Obama presidency they were renewed for 2 years, now sunsetting at the end of 2012. What will happen? Some analysts predict that Congress will pass a temporary extension before the end of 2012, patching things up to continue for one more year. Which begs the question, what will they do during that year? We are faced with enormous tax uncertainty. Tax uncertainty is the economic risk individuals and businesses face when the amount and type of taxes cannot be accurately predicted.

Uncertainty about tax rates as well as the future cost of Obamacare is holding back business growth. How can anyone evaluate the economic effect of a decision if a large portion of the expense – the taxation of business transactions and business income, as well as the cost of employee benefits – is a complete unknown?

At the end of 2012, the top income tax rate will rise to 39.6%. The lowest bracket of 10% will increase to 15%. Taxes on capital gains and dividends will increase. The 15% rate on capital gains will move up to 20%. Qualified dividends now taxed at 15% will be taxed like other income with a top rate of 39.6%. If the cuts expire, there will be no more special rate for capital gains and no more qualified dividends.

The Alternative Minimum Tax (AMT), which is an alternative tax system originally designed to make sure high-income tax payers don’t escape paying income tax, will be applicable to many more taxpayers, raising effective rates. Because the AMT was not indexed for inflation, Congress has had to approve periodic fixes to keep it from affecting many more people than intended.

If Obamacare stays, there is a 3.8% tax on investment income for taxpayers with incomes over $200,000. A new .9% Medicare tax on incomes over $200,000 is imposed.

Without the Bush tax cut, the marriage penalty will be back, withholding rates will rise and the earned income tax credit will be reduced. The American Opportunity Tax Credit which provides a credit of up to $2,500 per student expires December 31, 2012.

The current federal estate tax exemption of $5 million is slated to drop to $1 million on December 31, 2012. This is a huge drop and leaves many people in a quandary over their estate plans. Not to mention the top estate tax rate goes from 35% to 55%.

The effects of tax uncertainty are widespread. For example, the National Restaurant Association (NRA) reports that about three in ten restaurant operators have put expansion/improvements projects on hold because they’re uncertain whether Congress will extend the 15-year depreciation schedule for spending on construction and improvements. If restaurants proceed with the projects they have put on hold, the result would be $7 billion in direct construction spending by restaurants; a $23 billion overall economic impact as this construction spending ripples across other industries; and 200,000 new jobs across all U.S. industries, the NRA’s research department estimates.

Congress let the 15-year write-off period for restaurant construction and renovations expire at the end of 2011, allowing the depreciation schedule for such expenditures to revert to 39.5 years. Nearly 100 members of Congress are backing NRA-supported bills, S. 687 and H.R. 1265, to make the 15-year schedule permanent.

Another example is the quandary faced by individuals trying to plan for retirement. The Social Security and Medicare systems are stressed. Would-be retirees have to be responsible for

savings for their own retirement. Not only must they manage their investments but they also need to plan around taxes – IRAs, Roth IRAs, 401Ks, mutual funds, stocks, bonds, products have made taxes very complicated. An increase in taxation of dividends and capital gains can have a dramatic effect on retirement income.

Dividend income and capital gains is the kind of income used for paying bills, purchasing prescription drugs, keeping the air conditioning going in the summer, and paying property taxes. For senior citizens, higher capital gains taxes and dividend tax rates can be especially hurtful.

Then there’s the Obama administration proposal to take away the tax break for tax-free municipal bonds for wealthier tax-payers – talk about uncertainty! Budget projections show that the current budget trajectory is grossly unsustainable. The tax changes required to balance the budget in the future could be enormous. We need a fair, predictable tax policy. Now.