Lots of Tax Hikes Coming in 2011

Tax increases will hit businesses and individuals, and don’t think for a minute that only the wealthy will feel the pain.

By Joan Pryde, Senior Tax Editor, the Kiplinger letters

April 24, 2009

Think taxes are too high now? Just wait: Congress is all but certain to raise them a couple of years from now. Tax increases will hit both businesses and individuals -- and not just singles making more than $200,000 a year and married couples over $250,000 a year. They’ll be the first to get pinched, but not the last. There’s just not enough revenue that can be drawn from the wealthy without crippling the economy, so in time, middle incomers will feel a bigger bite, too.

Higher taxes will be part of a major overhaul designed to simplify the tax code, though it won’t do more than tinker around the edges. The legislation will have cuts as well as hikes, though more of the latter. Putting everything in a catchall piece of legislation dilutes opposition to any one unpopular provision. Figure on tax increases taking effect in 2011, assuming the economy is growing steadily. At that point, reducing the deficit will be the top priority. The debt is simply unsustainable over the long term.

Here’s what’s rising to the top of the list of probable hikes for individuals:

• Boosts in top marginal rates from 33% and 35% to 36% and 39.6%. No change in the other marginal rates seems likely.
• A higher rate on capital gains and dividends, but only for those in the top brackets. They will probably be hit with a 20% rate, though it could go a little higher.
• Caps on itemized deductions for top earners. Obama’s push to limit the value of deductions at 28% ran into a wall of opposition from charitable groups, but he’s not giving up. Some way of curtailing the tax break still seems likely by 2011.
• No repeal of estate taxes, but count on an exemption of at least $3.5 million, and it could be set as high as $5 million if the Senate prevails. Estate tax legislation will include spousal transfers, making the exemption $7 million or more for couples. The estate tax rate will be capped at 45%, the same as it is now.
• More easings for the alternative minimum tax, but no repeal.

Businesses can expect a mixed bag of hikes and cuts, but with a higher total tax bill. Among the changes:

• Higher SECA taxes for owners of S firms and partnerships by blocking them in the future from skirting payroll taxes by taking their compensation as dividends instead of salary.
• New restrictions on worker classification to make it easier for the IRS to crack down on firms that treat workers as contractors who are really employees.
• And elimination of some tax breaks for big corporations, including the deduction for domestic production, accelerated depreciation and incentives for foreign income and oil production.

But there may be a silver lining, at least for big corporations: Congress will consider lowering the 35% top corporate tax rate by several percentage points.

Longer term, tax hikes will go even further and hit more people and businesses. The only other option is deep cuts in spending, including Social Security, Medicare and defense, and the public won’t buy that. As a result, anyone making more than $100,000 a year will be at risk for higher taxes. The most likely option is to raise the cap on income subject to payroll taxes. It now stands at $106,800.

The increases will make many unhappy. They already see the burden as high, a point made clearly at those “tea parties” on April 15. Lumping together income, excise, payroll and other taxes, the average rate paid today is 21¢ on every dollar of income, according to a recent Congressional Budget Office analysis of data from 2006, the most recent year for which data are available. That’s the same as in 1982, after the Reagan tax cuts, and 2¢ less than at its peak under Clinton. For the top 20% of taxpayers, the average rate is higher: 26¢. That compares with 24¢ in 1982.