The Homa Files

OK, what’s the effect if Obama lets the Bush tax cuts expire? Big hurt or little hurt ?

Here’s a first cut …

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Base Case

Assume a married couple earning a combined $250,000 in taxable income.  Their tax liability based the 2009 tax rate schedule would be $60,320 — an effective tax rate of 24%. 

Literally reverting back to the pre-Bush 2000 tax rate schedule, they’d owe $73,048 — a 29% effective tax rate — and a 21% increase over the current tax rates.

That’s a big hurt … and probably an unlikely worst case scenario.

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Likely Obama Plan

Remember that Obama has often said “not a dime more in taxes for families making less than $250,000″ … and sometimes said the same for individuals making less than $200,000.

In fact, according to the Tax Foundation, the plan outlined in the Obama administration’s budget is to allow:

• The top tax rate to revert from 35% to 39.6%. 
• The 33% tax rate to revert to 2001 law (rate of 36%) but the income threshold where that bracket starts will shift up to $250,000 in taxable income (couples) and $200,000 for singles
• The rate on long-term capital gains to revert to 2001 law (rate of 20%) but only for couples with over $250,000 in AGI the year the gain is realized ($200K threshold for singles)
• The rate on dividends to be hiked to long-term capital gains rates, i.e. up to 20%, but below ordinary income tax rates.

  Excerpted from Tax Foundation: Fate of Bush Tax Cuts Uncertain As Expiration Approaches, March 25, 2010   http://www.taxfoundation.org/research/show/26062.html

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If the Tax Foundation is right, here’s what the brackets would look like for married couples per the Obama budget:

If Obama keeps his word on this one, our illustrative couple earning $250,000 won’t pay higher income taxes.

What about their friends who earn more and have more wealth to spread around ?

Well, a couple earning $500,000 would have their tax liability go from $137,500 (an effective tax rate of about 27.5%) —  to $150,000 (an effective tax rate of about 30%) — roughly a 9% increase in their taxes paid.

Draw your own conclusion whether that’s a lot or a little …

Note: This is only the increase due to the tax brackets shift if the Bush tax cuts are allowed to expire … it does not consider:

• The impact of the likely increase increase in the capital gains tax rate (from 15% to 20%), or the increase in the dividends tax rate (from 15% to either 20% or the ordinary income tax rate)
•  … or the triumphant return of the marriage penalty (on steroids this time)
•  … or the 3.8% payroll tax surcharge on AGI over $200,000 (including dividends and capital gains)  to be added in 2013 to pay for ObamaCare. 

I’ll cover capital gains and dividends below … and  the marriage penalty and ObamaCare payroll tax surcharge in subsequent posts.

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Estimating your tax hit

Here are some back-of-the-envelope ways to ballpark how much more you’ll be paying in income taxes in 2011 …

If your taxable income (AGI minus deductions) is less than $200,000 (individuals) or $250,000 (couples) — and if Obama keeps his campaign pledge — then your income taxes won’t go up.

If taxable income is over the thresholds …

The tax rate on capital gains will go up 5% … and the tax rate on dividends will go up at least 5% (to the capital gains tax rate) and maybe all the way up to ordinary income tax rates.

For ordinary income, the effective (not marginal) tax rate increase on ordinary income will be about 1/2% for each $100,000 of taxable income (i.e. ordinary income plus dividends and capital gains) over $200,000.

For example, assume a couple has $200,000 in taxable ordinary income and $100,000 in dividends and capital gains, giving them total taxable income of $300,000.   Their tax hit will be about $6,000 — $5,000 from the increase in dividend and capital gains tax rates (5% X $100,000) and $1,000 from the increase in the effective rate on ordinary income ($300,000 minus $200,000 = $100,000 => 1/2% rate increase times $200,000 = $1,000).  In rough numbers, their income taxes would go from $67,000 to $73,000 — an increase of almost 9% — and their effective tax rate would go from 21% to over 24%.

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Here’s a handy chart for eyeballing 2011 effective ordinary income tax rates at a range of taxable income levels. 

Technical note: Remember to separate out capital gains and dividends from taxable ordinary income — since they get a 5% hit. But, use total taxable income (ordinary income plues dividends and capital gains ) to estimate the increase in the ordinarary income effective tax rate.

In a subsequent post, I’ll incorporate the ObamaCare 3.8% payroll tax on AGI over $200,000 to be added in 2013 and look at the return of the uber-marriage penalty.

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Next up: The payroll tax surcharge …  add 3.8% for all income over $200,000

This entry was posted on April 8, 2010 at 7:59 am and is filed under Taxes. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.