Wednesday, December 22, 2010

How Will the Obama Tax-Cut Deal Affect You?

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How Will the Obama Tax-Cut Deal Affect You?

On December 17th, 2010, President Obama signed a $858-billion tax-cut package into law. Here are the important points in this package that may affect your personal finances.

Bush Tax Cuts Extended

First of all, the tax cuts put into place by President Bush in 2001 and 2003 are extended for all income levels for two years, until the end of 2012. This means that the lower tax brackets we have enjoyed for the past decade will not change very much. Capital gains and dividends will still be taxed at the current rates, so there is no need to sell all your investments at the end of this year in anticipation of higher capital gains rates. The $1,000-per-child refundable tax credit is also staying for at least two more years instead of reverting to $500 per child. Another important consequence of the Bush tax cuts is that the marriage penalty was lessened for couples where the husband and wife have similar incomes. Since Obama extended these tax cuts, this means that the marriage penalty will not increase.

Payroll Taxes Reduced

The Social Security taxes paid on wages will be reduced 2% for 2011 only. Basically, workers will pay 4.2% of their wages instead of 6.2% in 2011. The wage ceiling for Social Security taxes is $106,800, so this means that the maximum amount a person could save is $2,136. This is a good opportunity for everyone to contribute the 2% savings to a retirement account since you are given a reprieve from funding someone else's retirement.

Inheritance Tax Comes Back with a Smaller Bite

In 2010 the inheritance tax actually didn't exist due to Bush's tax package. In 2011 it is coming back, but it is much less harsh than the inheritance tax rates in the Clinton era. The Obama plan approved a 35% tax rate on estates worth over $5 million. Basically, estates under $5 million will pay no taxes, and that exempts most estates. If Obama did nothing, then the estate tax rate would have reverted back to 55% for estates over $1 million.

Alternative Minimum Tax Patched Again

The alternative minimum tax is a parallel tax system established in 1982 to guarantee that everyone pays at least some taxes, regardless of deductions. However, the problem with this tax system is that the exemption is not indexed for inflation, so if Congress does not change the law every year, more and more people are affected by the AMT. In this package, the alternative minimum tax patch is continuing into 2011, so millions of middle class families will not have to pay more taxes. The exemption is now $74,450 for married joint filers and $48,450 for single filers.

Unemployment Benefits Extended

The current levels of unemployment benefits will be intact for another 13 months. This doesn't mean that everybody is getting 13 more months of unemployment checks. What this means is that if the federal government decided not to pass this law, then unemployment benefits would stop at 26 weeks. Now that this law has passed, those who have not exhausted all their unemployment benefits will be able to collect the maximum amount of unemployment benefits allowed in their state for another 13 months. However, those who have already collected the maximum 99 weeks of benefits will not get any extension.

In summary, this package was passed so that Americans will not feel a huge change in their finances. If Congress and President Obama did nothing, then the Bush tax cuts would have expired by law and everyone would have had to pay more taxes. However, the package pretty much guarantees that taxes will have to be raised in the future because this is basically more deficit spending. It's in the spirit of "consume now and pay the consequences later," and it seems to be the American way.


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