Starting January 1, 2011, Washington Democrats will impose a $3.8 trillion tax hike on hard-working Americans, resulting in higher taxes for every American who pays income taxes, as well as on small businesses, the engines of job creation.  Unfortunately, Democrats have done nothing to disarm this ticking tax bomb, and even America’s senior citizens will be hit by this massive tax increase.  Among the most significant 2011 tax increases that will affect seniors:

• The tax rates on capital gains and dividends will rise significantly, imposing an average tax hit of $1,700 on more than half of all seniors who pay income taxes.
• The 10% bracket will be eliminated, raising the lowest tax rate to 15% and costing 88 million taxpayers – including every senior who pays income taxes – an average of $503 in higher taxes in 2011.
• The death tax will be reinstated with rates as high as 55%.

Below are some further details about these looming tax increases that will directly affect senior citizens.  For more information about the Democrats’ $3.8 trillion tax hike, see Part I of this series for an overview, Part II for examples of how it will affect typical taxpayers, and Part III for the specific impact on middle-class families.

Higher Taxes on Seniors’ Retirement Savings Portfolios

Impending tax increases on capital gains and dividends – detailed in the table below – will hit seniors particularly hard.  Seniors will feel the impact not just in terms of the higher taxes paid on realized capital gains and dividends, but also in terms of depressed values of stocks held either directly, through taxable mutual funds, or through retirement savings vehicles – such as IRAs and 401(k)s – upon which seniors rely to supplement their Social Security benefits.  These higher taxes – and evaporated wealth¹  – will cost many seniors the income they depend upon to pay for housing, food, medical care, and other monthly bills.  

According to two recent Tax Foundation studies of IRS data taken from 2008 tax returns that can be found here and here,  Americans over the age of 65 earn the bulk of all dividend and capital gains income, considerably more than any other age group.  Specifically, the Tax Foundation found that senior citizens:

• Earned more than $77 billion in dividend income in 2008, a figure representing 48% of total dividend income earned by all Americans that year; and

• Earned more than $150 billion in capital gains income in 2008, a figure representing 30% of total capital gains income earned by all Americans that year.

New estimates from the Joint Committee on Taxation (JCT) confirm just how hard the Democrats’ 2011 tax hikes on investment income will hit seniors’ retirement savings portfolios.  According to JCT, 8 million tax returns filed by senior citizens will face higher taxes on investment income as a result of Democrats’ 2011 tax hike.  This represents more than half of all tax returns filed by senior citizens, each of whom will have to pay an average of $1,700 in higher taxes – a particularly onerous burden for senior citizens who live on fixed incomes.  Additionally, another 18 million non-senior taxpayers will write larger checks on April 15 due to this tax increase – meaning roughly one-third of all taxpayers hit by higher investment taxes are elderly.  

* Because of the reinstatement of additional, hidden tax rates (see Part I of this series), while the top statutory capital gains rate will be 20% in 2011, the top effective rate will actually be 22%.  For dividends, while the top statutory rate will be 39.6% in 2011, the top effective rate will actually be 41.6%. 

Note that, under the Democrats’ new health law, beginning in 2013, investment income will be subject to an additional 3.8% surtax for single taxpayers earning more than $200,000 and married couples earning more than $250,000.  This will bring the top statutory rate on capital gains to 23.8% and the top statutory rate on dividends to 43.4% in 2013.  Because of the additional, hidden tax rate increases described in Part I of this series, however, the top effective rate on capital gains will be 25.8% in 2013, and the top effective rate on dividends will be 45.4%.

10% Bracket Eliminated

Currently, the lowest tax bracket is 10%, and that bracket applies, in 2010, to the first $8,375 of taxable income for single filers (including seniors) and to the first $16,750 of taxable income for married couples filing jointly (including married seniors).  In 2011, however, the 10% rate will disappear, and a higher 15% rate will be applied to the very first dollar of taxable income earned by all Americans, including seniors on fixed incomes.  JCT estimates that the elimination of the 10% bracket will cost 88 million taxpayers – including every senior who pays income taxes – an average of $503 in higher taxes next year.

Dollar amounts are based on JCT estimates of various tax parameters reflecting expected inflation adjustments for 2011.

Reinstatement of the Death Tax

For 2010, the estate tax is completely repealed.  Unless Congress acts, however, the estate tax will return in full force next year, with a top rate of 55% on the assets of taxable estates, after subtracting an exemption of $1 million (not adjusted annually for inflation).  In many cases, this tax represents double or even triple taxation:  the taxpayer paid tax when the income was earned, paid tax again on dividends or interest when that after-tax income was later invested, and then the estate has to pay tax on the assets purchased with that previously taxed income before those assets can be passed on to the taxpayer’s heirs.

Many senior citizens have spent their entire lives working, saving, and investing their assets to be able to pass along the fruits of their labor to their children and grandchildren.  But if the Democrats’ 2011 tax hike is allowed to take effect, seniors who have accumulated assets of even a dollar more than $1 million – including seniors whose only asset is a home that happens to have appreciated significantly in value – will once again find their estates subject to the death tax.

While the effect of these Democrat tax increases on any particular senior citizen will depend on his or her own specific facts and circumstances, it is clear by any measure that this is a massive tax hike that seniors simply can’t afford.  For more detail about the effect of the Democrats’ 2011 tax increase on small businesses, stay tuned for Part V of this series, coming soon.

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¹Barclay’s Capital, for instance, has estimated that the higher taxes on capital gains and dividends will cause an 8.6% drop in the S&P 500 Index, meaning that even seniors whose investments are limited to tax-preferred accounts will feel the effects of this tax increase (see, e.g., http://thehill.com/blogs/on-the-money/domestic-taxes/111597-new-report-shows-86-percent-drop-in-stock-markets-if-bush-tax-cuts-expire).