Hold On to Your Wallet: Taxes Are Likely to Increase Soon

Now that the US economy appears to be on the mend, can higher taxes be far behind?

It's only a matter of time, say many experts.

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AP

President Obama is facing a federal deficit in the trillions, two foreign wars and the projected high cost of healthcare reform, so he may have little alternative, they say.

"He's going to be forced to raise taxes," says Robert Ricketts, professor in taxation at the Rawls College of Business at Texas Tech. "Budgetary reality requires it...The question just becomes what taxes will increase and by how much."

The president says he can keep his campaign promise and not raise taxes on those making less than $250,000 a year. That leaves upper-income Americans as the primary target.

"Obama campaigned on raising taxes on higher income individuals," says says Mark Luscombe, a principal analyst at CCH, a tax and business law information provider. "That means he's likely to push very hard to make that happen, especially in view of the growing deficits. The increases have been delayed somewhat by the recession. But as that ends, the push will be renewed."

Some experts think there could even be higher taxes this year, though any increases before the economy is fully recovered could face significant public opposition.

"It's entirely possible we could see tax increases before the end of 2009," says Donald Williamson, professor of taxation at American University's Kogod School of Business. "This could be in connection with health care reform or to help pay for tax provisions set to expire this year."

The uncertainty about what taxes will go up—and when—makes tax planning difficult.

"I'm not sure what to tell our clients," says Joe McLeod, a tax partner at Cherry, Bekaert & Holland in Raleigh, North Carolina. "Until this all plays out, it's hard to say what advice to give. But you can expect some taxes on higher incomes to go up."

Among the closely watched taxes by upper income levels and those expected to increase between now and the end of 2010 are:

  • Capital Gains and Dividends: Could be raised from the current level of 15 percent to 20 percent
  • Marginal income rates: Expected to be raised from the current 35 percent to 39.6 percent
  • Estate Tax: Set for zero rate in 2010. The top rate for this tax will increase to 60 percent on January 1, 2011, and the value of an estate exempt from taxation will shrink to $1 million

President Obama did cut taxes as part of the economic stimulus package—a tax credit for all single filers making less than $95,000 and for joint filers making less than $190,000. Even some in the upper middle brackets got a benefit in the stimulus—the AMT or alternative minimum tax patch was extended for 2009, raising exemptions and reducing taxes on those making on average, $165,000 a year.

But analysts say those cuts leave Obama and a Democrat led Congress little option but to go after what they see as extra tax benefits for upper income levels.

"The administration supports raising taxes on those that they feel are best to afford it," says CCH's Luscombe. "That means incomes of more than $250,000."

For those in that $250,000 bracket, capital gains are a big target after a Republican Congress and president cut them, say analysts.

"Capital gains taxes could be raised for top income brackets, since that would impact the higher income taxpayers more than lower income ones and would be favored by Democrats," says Mary Harris, business department chair at Cabrini College. "Of course, Republicans and business would fight against that."

And any efforts to end the estate or so called 'Death Tax' are unlikely to happen.

"Bush wanted a permanent repeal of the estate tax but that trend is going to be reversed," says Bill Smith, director of the national tax office at CBIZ MHM, an accounting provider firm. "They will be adjusted probably moving to a higher $3 million non-taxable estate instead of the $1 million they would fall back to in 2011."

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Beyond the expected repeal of the Bush tax cuts, President Obama will look to healthcare taxes to pay for reform says Terry Connelly, dean of Golden Gate University's Ageno School of Business.

"Obama clearly opened the door in his (healthcare reform) speech to the joint session of Congress to taxing healthcare insurance packages at the 'Cadillac' level—those packages seen as excessive," says Connelly. "That will effect some big union plans as well as senior business executives."

"It's still unclear what taxes might be raised in conjunction with healthcare reform," says Luscombe. "But there could be a penalty tax on individuals and businesses that do not obtain health coverage."

Still, if President Obama and the Democrats want tax increases, even on the higher income levels, they have their work cut out for them analysts say.

"I don't think the general public is ready at all for a tax rise," says Harris of Cabrini College. "With the unemployment rate at an all time high and salary increases small or non existent, everyone is still in a conservative and uncertain state regarding the economy and their personal financial conditions."

And for those who are against tax hikes of any kind, they are the last thing a troubled economy needs.

"Positive cash flow is the critical element for the business sector to climb out of the recession," says Jim Malski, a former CPA at PricewaterhouseCoopers and president and founder of the business consulting firm The ActionCOACH. "Raising taxes will reduce cash flow and prevent an economic recovery."

And one analyst believes tax increases won't be enough to help eliminate the bulging deficit.

"If Congress is truly working to bring down the deficit, they have to cut spending," says Cherry, Bekaert & Holland's McLeod.

"Our annual deficit is approaching $1.8 trillion and will be $20 trillion by 2020. Tax raises would only be about 10 or 20 percent of what they spend. That won't do enough to cut the deficit. Raising taxes is just a feel good move," says McLeod.

But cutting government red ink is exactly the reason for tax hikes says Golden Gate University's Connelly. "There must be tax increases to fund the deficit in order to avoid the much more debilitating 'tax' known as inflation if we continue for too long to enable the deficit by the Fed printing money," says Connelly.

And states already raising taxes on their own to close budget shortfalls, are still in need of money from the federal government says Lynn Ballou, a partner at tax planning firm Ballou Plum Wealth Advisors.

"States are in a world of hurt," she says. "Here in California, property taxes have plunged with falling real estate taxes. I expect that Washington will be a source for more state project funding."