Expiring Tax Laws Create Uncertainty (Commentary)

Barring congressional action and approval by the president, taxpayers are likely to encounter a vastly changed federal income tax landscape on Jan. 1, 2013. A number of significant, but temporary, tax reductions were passed in 2001 and 2003, extended in 2010, and currently expire Dec. 31, 2012. With that deadline approaching and in the current political climate, congressional action is uncertain at best.

A more recent provision reducing part of the Social Security tax on employees from 6.2 percent to 4.2 percent and the self-employment tax by 2 percent is also scheduled to expire on Dec. 31. An employee earning $50,000 a year would face a $1,000 tax increase.

Perhaps the hallmark of the 2001/2003 tax cuts was the reduction in tax rates and the addition of a new, lower 10 percent rate on some income. The table below indicates the current rates in effect and the rates that would apply should no tax legislation be enacted:

Current    2013 Rate
Rate    Without Legislation
10.0%    15.0%
15.0%    15.0%
25.0%    28.0%
28.0%    31.0%
33.0%    36.0%
35.0%    39.6%

Another major feature of current tax law is the lower tax rates applied to long-term capital gains and dividend income. For these categories, income that would otherwise be taxed at any of the highest four rates (25 to 35 percent) is taxed at 15 percent. Income that would otherwise be taxed at 10 or 15 percent is taxed at a zero percent rate (i.e., is untaxed). After the provision sunsets at the end of 2012, the maximum tax rate on long-term capital gain would revert to 25 percent and dividends would be taxed at ordinary tax rates.

After Dec. 31, certain high-income taxpayers could again face the loss of some or all of their deductions for certain itemized deductions and for the personal and dependency exemptions ($3,800 per exemption in 2012). This is accomplished through a "phase-out" where the amount of the deduction is reduced as the taxpayer’s income increases.
The current child tax credit for children under 17 of $1,000 per qualifying child is scheduled to return to a previous maximum of $500. A "phase-out" based on the taxpayer’s income continues.

Taxpayers can claim certain credits for the payment of qualifying tuition and fees for post-secondary education. The more generous of these credits, the Hope Scholarship Credit, limited to $1,800 per year, applied only to the first two years of higher education. For 2009-12, the credit (renamed the American Opportunity Tax Credit) was increased to a maximum of $2,500 and was available for four years of higher education. After 2012, the less favorable provisions of the Hope credit will apply. This credit is also subject to a rather restrictive "phase-out" based on income.

A business tax provision that has been touted as an economic stimulus allows additional, first-year ("bonus") depreciation on most new business equipment. The amount of first-year depreciation has been 30 percent, 50 percent or 100 percent and has most recently been reduced to 50 percent for 2012. After 2012, "bonus" depreciation is scheduled to expire.

Another similar tax provision allows the immediate expensing of certain business equipment. It is generally restricted to smaller businesses because the provision includes a "phase-out" as the cost of business assets acquired during the year exceeds a specified threshold. The recent history of this provision and the scheduled change for 2013 is shown below:

    Maximum
    Expensing    Phase-Out
Year    Deduction    Threshold
2007    $125,000    $500,000
2008-09    $250,000    $800,000
2010-11    $500,000    $2,000,000
2012    $125,000    $500,000
2013    $25,000    $200,000

Some dramatic changes in the estate tax for 2013 could also result from congressional inaction, including a lowering of the effective exemption amount from $5.12 million for 2012 to $1 million for 2013 and increased tax rates.

Congress could act on these and other tax issues. That action could come before the 2012 elections, in a "lame duck" session between the elections and the installation of the 113th Congress, or after the new congressional session begins in 2013. The concurrence of the then-sitting president would also be necessary. Given the current political climate, any of those scenarios is problematic.

More information on these and many other expiring tax provisions is available in a report from Congress’ Joint Committee on Taxation: "Legislative Background of Expiring Federal Tax Provisions 2011-2022," by visiting JCT.gov and searching for the report’s title.

Michael M. Watts, an accountant and lawyer, is associate professor of accounting at the University of Arkansas at Little Rock. Leon Mourton, a CPA and MBA, is an instructor of accounting at UALR.