There has been a lot of fighting about the possibility of raising taxes on the highest-earning Americans.There has also been frustration about how much President Obama’s healthcare plan will eventually cost Americans, especially high-income Americans.
And there have been fisticuffs over the expiration of the “Bush tax cuts,” which have now been in force for so long that most people have forgotten what life was like before them (in part, a federal budget surplus).
Until recently, however, these concerns have seemed academic–something that might happen happen at some point in the distant future.
Well, that future is almost here.
Andrew H. Friedman of Eaton Vance recently summarized the tax changes that will take effect in 2013, about 10 months from now.
The changes reflect the double-whammy of the new healthcare tax (3.8% on dividend income and other forms of unearned income) and the expiration of the Bush tax cuts. The combination of the two is startling, even for those who support raising taxes for rich people.
Importantly, these tax changes are already a matter of existing law. To prevent them from taking effect, Congress would have to agree to stop them from taking effect.
What’s the bottom line on these changes?
Americans who earn more than $200,000 a year ($250,000 for families) are about to pay the highest taxes they have paid in a quarter-century, since the late 1980s. The top tax bracket on ordinary income will jump from 35% to 40% (or higher in the case of the self-employed). The tax rate on dividends, meanwhile, will leap from 15% to 43%.
Here’s Andrew Friedman:
Republicans believe the Bush tax cuts should be extended for all taxpayers. Democrats believe they should be extended only for the middle and lower classes. President Obama has said he will veto any further extension of the Bush tax cuts for upper income families. If the President carries through on that threat, then either the Republicans must accept a compromise that raises taxes only on the affluent or watch the tax cuts expire for everyone. Under either scenario, affluent taxpayers will face higher taxes in 2013.
And that is not the end of the story.
To help finance the health care reform law passed in 2009, Congress approved a new tax on investment income to take effect in 2013. Beginning next year, families whose overall income is above $250,000 (individuals with income over $200,000) will pay an additional tax of 3.8% on taxable investment income (e.g., interest, dividends, capital gains, rents, royalties). This additional tax will not apply to non- taxable income, such as tax-exempt municipal bond interest, or to amounts withdrawn from qualified pension plans and IRAs.
When the new tax under health care reform is added to the expiration of the Bush tax cuts, in 2013:
- The top tax rate on ordinary income will rise from 35% to 43.4%—an increase of almost 25%*
- The top tax rate on capital gains will rise from 15% to 23.8%—an increase of almost 60%
- The top tax rate on dividends will rise from 15% to 43.4%—an increase of almost 200%
- The estate tax exemption will drop from $5 million to $1 million and the estate tax rate will rise from 35% to 55%—an increase of over 55%
Most important, Congress need not pass a single piece of tax legislation in 2012 for these tax rates to take effect in 2013. They will happen by default.
*UPDATE: Several sharp-eyed readers say that Friedman’s calculation on ordinary income here is wrong. The top ordinary income bracket will increase to 39.6% (40%). The healthcare tax will then be applied to dividend income. Apparently, in the case of the self-employed, the healthcare tax will have the effect of raising the ordinary income tax to the 43% that Friedman cites. If anyone can explain the specific details of this, please do so in the comments below.
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