The mother of all tax storms is heading our way. And it’s due to arrive at the end of the year, raising rates for more than 100 million Americans.
It is a storm that could sink the economy, as Congress’ number-crunchers at the Congressional Budget Office warned late last week. It said failure to act will put the economy back in recession and that unemployment will soar from 8.2 percent to 9.1 percent, or roughly 2 million more jobless on the street.
“The expiration of the Bush tax cuts at the end of 2012,” says lawyer and CPA Leon LaBrecque, “affects virtually every individual taxpayer in the United States, as well as corporations and nonprofit institutions.”
And look out for your 401(k)! As the capital-gains tax rate soars to 20 percent, many investors will look to cash out of equities to pay the current 15 percent rate. That will sink the market.
If Congress and the president do nothing between now and the end of the year, LaBrecque adds, the expiration of the tax cuts “would constitute the biggest tax increase in more than 50 years.” He says the biggest misconception of the tax storm is that only the rich will be hurt.
As an illustration, he cites the example of one client. She is a single working mother making $37,000 a year. The expiration of the Bush tax cuts, he says, will also be painful for her. She will pay 76 percent more in taxes.
So tax professionals are cautioning clients to develop tax-reduction strategies now.
Chicago tax attorney David Henderson, who advises high net worth clients, says middle-class taxpayers should reverse the most common tax-planning strategies that have been used.
Forget about deferring income and paying taxes later. Taxpayers should assume that they are going to get socked in January with higher tax rates, he says.
“The tax rates you’ll pay this year will probably be the lowest rates we’ll see in our lifetimes,” Henderson predicts. That includes the capital-gains taxes that you pay when you sell an asset, such as a property or a stock.
“So look in your portfolio. And if you have long-term capital gains, now is the time to sell those,” Henderson says.
Investors should pay taxes now at what will likely be much lower rates, according to Henderson. Tax pros also say that the value of deductions, such as money given to charity, will become more valuable as tax rates zoom in 2013. “Say you’re going to make a charitable contribution late in December. Wait a week or two to write the check. The charity still gets the contribution, but the deduction will be more valuable in January,” Henderson says.
Along with a scheduled $100 billion in federal spending cuts due to go through unless Congress acts, the tax storm has the potential to do more than hurt individual pocketbooks. It could, warns the Council on Foreign Relations, drive the economy off a tax-and-spending cliff.
“The abrupt onset of such significant budget austerity in the midst of a still-fragile economic recovery has led most economists to warn of another recession in 2013 if Washington fails to intervene in a timely fashion,” according to a paper from the council.
Higher taxes and spending cuts are also spooking employers, the council said.
“Our customers are concerned,” UPS CEO Scott Davis told The Hill, a publication that covers Congress. “They’re not going to invest. They’re not going to hire people. They’re not going to stock inventory with all that uncertainty.”
But couldn’t this spending reduction and tax storm blow past us? Couldn’t Democrats and Republicans prevent the nation from going over a fiscal cliff by making a last-minute deal?
“Very unlikely,” Henderson says.
Here are some of the tax changes that automatically begin on Jan. 1, 2013, unless Congress acts.
* Social Security rate goes up from 4.2% to 6.2%
* The 10% tax bracket expires and becomes 15%
* The 25% rate rises to 28%
* The 28% rate goes to 31%
* The 33% rate goes to 36%
* The 35% rate goes to 39.6%
* The Earned Income Credit is eliminated
* The child tax credit falls from $1,000 to $500
* The Alternative Minimum Tax reverts to 2001 levels
* The long-termcapital gains on middle- and upper-income taxpayers go from 15% to 20%