How Expiration of the Bush Tax Cuts Will Affect Individuals and Businesses

As the election season kicks into full gear, it will be impossible to avoid discussing the state of the nation's economy. One of the major changes America may face is the expiration of tax cuts that started during George W. Bush's years in office and the implications their expiration will have on small businesses and those with a high net worth.

Countdown to January First

The tax law changes - commonly referred to as the "Bush tax cuts" - are scheduled to expire on January 1, 2013. If Congress fails to extend them, many Americans will experience a tax increase. Many are skeptical that Congress - which has not moved on extending the cuts in two years - will take action before the presidential election. Some believe that once the election is over, Congress will not have the political will to make changes to the tax code.

Since it is uncertain what will happen to the Bush tax cuts in 2013, it is wise for business owners and individuals to educate themselves on how the expiration of the cuts may affect their tax burdens.

Lower Rates Will Disappear

Currently, all Americans enjoy the lower tax rates the Bush tax cuts provided. If the cuts expire, income tax rates will rise across all tax brackets. Under current rates, those in the lowest bracket pay taxes at a 10 percent rate while those in the top income bracket pay at a 35 percent rate. These rates will rise to 15 percent and 39.6 percent, respectively.

If the cuts expire, the lowest tax bracket will disappear and the lowest tax rate will become 15 percent. The tax rates for middle-income earners will increase from 25, 28 and 33 percent to 28, 31 and 36 percent, respectively.

Other tax rates will also increase. The employee payroll tax rate will increase two percentage points to 6.2 percent. Likewise, the estate tax rate will also increase from 35 percent to 55 percent, while the value of estate assets excluded from estate taxes drops from $5.12 million to $1 million. Lastly, the tax rate on income from realized capital gains will increase from 15 percent to 20 percent.

Dividends Will Be Taxed As Income

One of the most dramatic changes that will occur if the Bush tax cuts are allowed to expire is the treatment of income from dividends. Currently, dividends are taxed as capital gains, with a top rate of 15 percent. If the cuts expire, income from dividends will be taxed as ordinary income, meaning that high-income earners could be taxed 39.6 percent on dividends. People who earn most of their income from investments with dividends will see a large jump in their tax rates.

Credits and Tax Breaks Will Disappear

In addition to the rise in tax rates, allowing the tax cuts to expire will also eliminate several credits and tax breaks American currently enjoy. The child tax credit will be halved to $500 per child, while the so-called marriage tax penalty will reappear, making the tax burden greater for married couples filing jointly rather than filing separately. Itemized deductions for higher-income individuals will be reduced if their adjusted gross incomes exceed a certain threshold. Additionally, allowing the tax cuts to expire will cause over 70 other tax breaks to expire.

If Congress allows the Bush tax cuts to expire, higher-income earners and small business owners face burdensome tax rates. Individuals and business owners are urged to contact an experienced tax lawyer to assess the ramifications of the possible changes. Even if the tax cuts are extended beyond January 1, periodic tax planning with a legal professional is a wise decision.