The primary cause of all this uncertainty is the question of whether individual tax rates will rise as currently planned. Currently, the following changes are scheduled to take effect on January 1, 2013 if Congress fails to take action to prevent them:
- The six federal income tax brackets now in effect (10%, 15%, 25%, 28%, 33% and 35%) will be consolidated in five higher brackets: 15%, 28%, 31%, 36% and 39.6%
- Some high-income households will be ineligible for certain itemized deductions or personal exemptions
- Net investment income, including qualified dividends, will be taxed at the taxpayer’s income tax rate, which in some cases could be as high as 43.4%
- The capital gains tax rate will rise to 20% from 15%
- The estate tax exemption of $5 million will fall to $1 million and the estate tax rate will rise to 55% from 35%
- The Social Security tax withholding rate will return to 6.2% from the current level of 4.2%
The perennial challenge of passing an alternative minimum tax patch is another cause for concern. If Congress fails to pass a retroactive patch, married couples with AGI as low as $45,000 and single taxpayers with AGI of $33,750 would be subject to the AMT in 2012.
Faced with these potentially higher tax rates in 2013, common wisdom calls for accelerating income and delaying certain deductions to avoid paying higher rates on higher income levels next year. But that strategy could backfire if Congress does reach a compromise that avoids the combination of higher taxes and drastic government spending cuts that threatens to drive the economy off the so-called “fiscal cliff.”
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