Obama would have high earners pay more

[Editor’s Note: This is the second installment of a three-part series by members of CBIZ Tofias and Mayer Hoffman McCann P.C. on potential changes in tax law.]

The Obama administration’s proposed income tax changes for individuals is a mixed bag, some favorable to taxpayers, some not. The administration wants to extend several temporary tax incentives targeted to middle-income earners. Higher-income individuals would pay more in income and capital gains taxes.
Making work pay credit
The American Recovery and Reinvestment Act of 2009 provides a refundable Making Work Pay tax credit of 6.2 percent of earned income, up to $400 for single taxpayers and up to $800 for married couples filing joint returns, for 2009 and 2010. The credit phases out for a single individual with modified adjusted gross income (AGI) between $75,000 and $95,000, and for married couples filing jointly with modified AGI between $150,000 and $190,000. The administration would make the credit permanent, reduce the phase-out rate from 2.0 to 1.6 percent and index the beginning of the phase-out range for inflation.
The Making Work Pay credit is technically claimed by taxpayers when they file their 2009 (and 2010) returns. However, Congress wanted to accelerate the credit, so that it is delivered in small increments through reduced payroll withholding. Consequently, individuals with more than one job and pension recipients may experience under-withholding. Married taxpayers whose combined income places them in a higher tax bracket may want to adjust their withholding.
Tax rates
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) lowered the individual marginal tax rates “temporarily” for a 10-year period. The current rates of 10, 15, 25, 28, 33, and 35 percent will sunset after 2010. The administration wants to extend the 10, 15, 25, and 28 percent rates for another 10 years, and reinstate the pre-EGTRRA top rates of 36 and 39.6 percent for individuals with incomes greater than $200,000 and married couples filing jointly with incomes greater than $250,000. Reinstating the 36 and 39.6 percent rates is estimated to raise $319.5 billion over 10 years. Administration officials have been unclear if the $200,000/$250,000 amounts refer to adjusted gross income or taxable income. A Treasury official said that the 36 percent rate – as well as proposed changes to capital gains and dividend tax rates – would start to apply to single taxpayers with taxable income greater than $200,000 minus the standard deduction and one personal exemption, indexed from 2009, and $250,000 minus the standard deduction and two personal exemptions, indexed from 2009, for married couples filing jointly. The administration also proposes to expand the 28 percent bracket to ensure that taxpayers earning less than these amounts would not experience a tax increase.
The current top rate of 35 percent starts at approximately $373,000 in taxable income for individuals and married couples filing jointly. The next highest rate, 33 percent, starts at approximately $172,000 in taxable income for individuals and roughly $209,000 in taxable income for married couples filing jointly.
Capital gains
In 2003 and again in 2006, Congress lowered the maximum tax rates on qualified capital gains and dividends. For 2009, the maximum capital gains and dividends tax rate is 15 percent (zero percent for taxpayers in the 10 or 15 percent brackets). These lower rates are scheduled to sunset after 2010. The administration wants to impose a 20 percent rate on qualified capital gains and dividends for individuals who then fall within the new 36 or 39.6 percent brackets. The zero and 15 percent rates would be made permanent. Imposing the 20 percent tax rate on capital gains and dividends for higher-income taxpayers is projected to raise $117.9 billion over 10 years. AMT patch
The administration’s fiscal year 2010 budget assumes that Congress will continue to “patch” the alternative minimum tax (AMT) as it did for 2009. The 2009 patch provides higher exemption amounts. Additionally, the nonrefundable personal tax credits are allowed to the full extent of the taxpayer’s regular tax and AMT liability.
Prospects for repeal of the AMT are dim as the tax raises huge amounts of revenue, which the government needs to offset projected deficits.
Itemized deductions
Whenever itemized deductions would reduce taxable income in the 36 and 39.6 percent brackets (revived after 2010), the tax value of those deductions would be limited to 28 percent. The proposal would apply to itemized deductions (including mortgage interest and charitable deductions) after they have been reduced by reinstating the pre-EGTRRA limitation on certain itemized deductions.
Under current law, the tax benefit of $10,000 paid in mortgage interest is $3,500 at the 35 percent bracket. The administration’s proposal would limit the tax benefit to 28 percent ($2,800) for higher-income taxpayers after 2010.
State and local sales tax deduction
Currently, individuals may take an itemized deduction for state and local general sales taxes instead of state and local income taxes. The administration would extend the state and local sales tax deduction through Dec. 31, 2010.

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Drew Colman (dcolman@cbiztofias.com) is a director at CBIZ Tofias, a provider of tax/consulting services. CBIZ Tofias operates in association with Mayer Hoffman McCann P.C., an independent CPA firm. The firm has offices in New Bedford, Newport and Providence.