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‘Consumers Are Paralyzed’ Over Tax Doubt

September 24, 2010

Congress halted plans to pass a major tax bill before the November elections, leaving taxpayers and financial advisers unsure of how to plan for the future.

One of three scenarios face Congress when it returns from the election recess: It will extend all of the Bush tax cuts of 2001, which expire this year; it will hammer out a new law, perhaps using some of President Barack Obama’s budget proposals; or lawmakers will let the cuts expire, which would mean higher rates for all taxpayers.

Meantime, “consumers are paralyzed,” said Dean Barber, a planner who heads the Barber Financial Group near Kansas City. “They have money to spend but they aren’t going to until they know where the tax burden will lie next year.”

The problem extends to business as well. “There are 29 million private businesses in this country, and they interact with our members,” said Barry Melancon, head of the American Institute of Certified Public Accountants. “Universally we are hearing that businesses are paralyzed by lack of capital and uncertainty over taxes.”

Here are key issues lawmakers still have to resolve.

Income taxes: Next year the top nominal income tax rate could rise to 39.6% if the Bush 2001 tax cuts expire or Mr. Obama prevails on Congress to enact his budget proposals.

If all the Bush 2001 cuts are extended, the top nominal tax rate will remain at 35%. But lawmakers face pressure to address these issues before the end of the year. If they don’t, all of the Bush 2001 cuts will expire and millions of low- and moderate-income taxpayers could see substantial tax increases, which may ignite a political firestorm.

Investment taxes: Next year the top rate on capital gains and dividends will remain at 15% if the Bush tax cuts are extended, or rise to 20% under Mr. Obama’s budget.

If the Bush tax cuts expire, the top rate on capital gains will also be 20%. But dividends would revert to being taxed as ordinary income, giving them a top rate of 39.6%.

Alternative minimum tax: The “patch” to narrow the reach of this levy, which bars deductions and raises federal taxes on upper middle-income taxpayers—especially on residents of high-tax states—hasn’t been passed for tax year 2010. If Congress doesn’t make this change, 32 million taxpayers will owe AMT for 2010, versus 5 million in 2009.

Estate tax: There is no estate tax in 2010. If Congress doesn’t act, then in 2011 the estate tax will return with an individual exemption of $1 million and 55% top rate.

One option is for lawmakers to return the estate tax next year to its 2009 level—a $3.5 million individual exemption and a top rate of 45%, although some lawmakers would like to raise the exemption further, to perhaps $5 million.

There is also sentiment in Congress and the Treasury for giving the heirs of those who die in 2010 the choice of using 2009 exemptions and tax rates.