Year End Investing Tax Tips 2009 - Special Report

Death—Health Care Reform—And Taxes

As taxpayers take the first steps in preparing their 2009 returns, they might find themselves thinking about what’s in store for 2010 and 2011. A struggling economy, an exploding federal deficit and the cost of a possible health care bill signal major adjustments ahead.

AP

"A bunch of things are going to change in 2010," says Brian Compton, president and co-owner of Tax Resolution Services, a tax guidance firm. "There will be a need to raise taxes with a crushing deficit and a probable double-dip recession. Taxes will be part of the discussion to resolve these issues.”

If the heath reform bill passes in its current Senate form, several tax hikes await you, possibly as early as 2010, including:

  • A 5.4-percent surtax on incomes above $500,000 (including capital gains and dividends).
  • A 40-percent excise tax on health coverage in excess of $8,500 (for individuals) $23,000(for families).
  • Taxes for most wage earners on all health insurance plans, brand-name drugs and biologics, and medical devices.

Other proposed taxes in the bill, such as a 0.5 percentage point increase in payroll taxes on individuals with incomes greater than $200,000, don't take effect until 2013.

If that’s not enough, analysts point to tax revisions on other fronts.

"Taxpayers have to keep their eyes peeled for changes on the state and local level," says Pace University tax professor Bridget Crawford. "With big states like New Jersey and New York in crisis, I wouldn't be surprised if local taxes started to spike."

The circumstantial need is certainly there. A recent study showed that tax revenues fell 10.7 percent for US states in the third quarter of 2009 from a year ago.

And in 2010, the opportunity for tax filers to choose to deduct their state sales tax payments instead of deducting their state and local income tax is gone.

The hot button items under discussion in 2010—as they were earlier this year—will be capital gains, dividends and ordinary income, and the changes that are expected will very likely be unpleasant, especially for investors.

“The current rate of 15 percent for capital gains is scheduled to expire at the end of 2010,” says Maureen McGetrick, a senior manager at tax and accounting firm BDO Seidman. “They could go up to 20 percent and dividends would be taxed at ordinary income rates. Taxes are going up next year and beyond."

Top personal income brackets are set to rise and the highest one, now 37 percent, could go as high as 40 percent

Another issue for Congress is the complicated Alternative Minimum Tax or AMT, as more people could be hit with it next year. Exemption levels for those filing jointly drop from $70,950 in 2008 to $45,000 in 2010. For single filers, the level drops to $35,750 from $46,700.

"Lawmakers are a little scared of what to do about the AMT," says John Barrie, a tax law attorney and partner at Bryan Cave, a business and litigation law firm. "But I think they will try not to increase the number of people who are targets. It's possible to see another one-year fix to keep the exemptions at 2009 levels.”

OK. That’s probably depressing enough. Now—the bright side.

Some of the better tax provisions of 2009 are extended to 2010. These include the first-time homebuyer’s tax credit, which runs until April 30 of 2010. In addition, income limits were raised for the credit to $125,000 for single buyers and $225,000 for couples and the credit extended to repeat buyers ($6,500).

Also in place for 2010 are the home-energy tax credit, the expanded tuition tax credit and computer purchases from 529's, allowing tax free payouts from 529 college savings plans to pay for computer equipment and internet access

Taxes
Casey Serin

And there's more push for green in 2010 with the plug-in, electric vehicle credit. Consumers will continue to get a credit of $2,500 to $7,500, depending on the car's battery capacity.

As for the controversial estate tax, it's not currently on the books for 2010. But that could change before 2009 ends.

The tax's rate of 35 percent and exemption of $3.5 million is scheduled to expire on December 31, 2009. It becomes zero percent for 2010. However, in 2011 the estate tax changes again, with a top rate of 55 percent and an exemption of $1 million.

"There's a bad joke about the estate tax," says Dr. Robert Carroll, senior fellow at the Tax Foundation. "It says 'good estate planning means dying in 2010.' That tells you what a lot of people think about it."

But it's not likely to go away with increased government spending and shrinking revenues.In fact, the House just voted to permanently implement a 45 percent rate on estates larger than $3.5 million. Married couples, could exempt a total of $7 million. The Senate has a similar proposal on its agenda but is currently embattled over the health care reform bill.

"Congress will probably agree before the end of the year on a temporary extension of the estate tax," says Crawford, "But it's not clear what will happen. Some Democrats want to let it go for 2010 and have it come back (in 2011) at the 55 percent rate. Others along with some Republicans want the $3.5 million exemption to be permanent now."

Taxes—real or hypothetical—will be a subject of great debate in Washington in the coming year. An unusual economic recovery along with two years of massive government spending and the expiration of the Bush tax cut program almost necessitate it.

"There's an opportunity to look at the bigger tax picture, says Barrie. “It's a very good time to simplify the IRS code and find out which deductions are really important," says Barrie.

He cites the revered mortgage interest deduction as a potential target; being among those who think it does not stimulate the economy.

There’s been talk about eliminating or at least reducing that benefit for years, if only for some income levels.

"I think you'll see an effort for a tax agenda next year," says Marc Gerson, a lawyer with Miller and Chevalier law firm and whose practice focuses on federal tax policy. "There is a need for continuing the stimulus and health care reform calls for taxing some of the higher incomes. What was started in 2009 will bleed into 2010.”