From the March 2009 issue of Wealth Manager Web • Subscribe!

Presidential Promises

Tax-code changes have averaged one-per-day over the past eight years--with 500 changes in 2008 alone, National Taxpayer Advocate Nina Olson announced in her annual report to Congress on Jan.7. An independent organization within the IRS, the Taxpayer Advocate Service helps taxpayers resolve complaints with the agency when problems cannot be resolved through normal channels.
Can we expect anything less this year? As tax season approaches, you will undoubtedly seek to address your clients' concerns in your newsletter, on your Web site, and in person. In last month's Wealth Manager, we discussed expectations for taxes on investment income. This month, we'll look at changes that affect individual earned income.

During his campaign for the presidency, candidate Obama repeatedly said he wanted to cut taxes for low- and middle-income families and boost them for high-income families. "No family making less than $250,000 will see their taxes increase," he stated. Now-President Obama is clearly committed to making permanent George W. Bush's tax cuts for families with annual incomes under $250,000 and single households with annual incomes under $200,000. He has been equally adamant about his support for repeal of tax cuts for people in the two top brackets

What do the president's promises mean for current tax rates that are scheduled to expire on Dec. 31, 2010? And what do they mean for your clients? The four bottom rates of 10%, 15%, 25% and 28% simply continue. But in 2011, the two top rates of 33% and 35% revert to the pre-2001 rates of 36% and 39.6%--although as a candidate, Obama set no timeframe for their return.

To add to the already mind-numbing complexity of the tax code, all six brackets change continuously because they are indexed--that is adjusted annually to reflect inflation. The rationale for indexing is relief from so-called bracket creep--the enrichment of the government at the expense of individuals pushed into loftier brackets even though their incomes only stay even with inflation.

Of course, the president might decide to put off implementation of his campaign pledge regarding the two top rates. Soon after the election, top aides indicated the tax cuts could be allowed to expire on schedule at the close of 2010--an unsurprising tack for a president-elect wary of increasing taxes at a time of turmoil in the financial markets and weakness in the economy--despite the certainty of record budget deficits and mounting public debt.

Marriage Penalty

The "marriage penalty" (or, depending on one's point of view, "sin subsidy") is a quirk in the tax code that enrages many couples. The penalty compels them to pay greater taxes on their combined incomes than they would as two unmarried single individuals who live together and report the exact same incomes. The 2001 tax act provides millions of two-income couples with penalty relief. But the relief is only partial and temporary. However, we can most likely expect the current rules to stay in effect after their slated expiration in 2010.

One of those changes placates most joint filers by increasing their standard deduction to twice the standard deduction for single filers. For 2009, that means $11,400 for joint filers and $5,700 for single filers, plus an additional deduction in 2009 and 2010 for state and local real estate taxes of as much as $1,000 for joint filers or $500 for other returns. There are additional amounts for blind individuals or those who have turned 65. Consequently, two non-itemizers who decide to wed no longer suffer the loss of some of their standard deductions. But if this rule is allowed to sunset after 2010, the standard deduction for joint filers would likely decrease.

Another helpful change for joint filers authorizes a larger slice of their income to be taxed at the 15% bracket rather than the next bracket of 25%. Again, unless renewed by Congress, this provision also expires after 2010.

Moreover, despite the rules that alleviate the marriage penalty, situations still exist where dual-income couples will lose more to taxes than they would as singles. True, the marriage penalty need not concern couples who have individual taxable income under the top end of the 15% bracket for singles which is $33,950 for 2009. Married or unmarried, they remain within the 15% bracket.

But suppose each spouse has taxable income for 2009 of $75,000. As single taxpayers, each person stays well below the top end of the 25% bracket ($82,250), whereas if they marry and file jointly, more than $12,000 of their combined income of $150,000 would spill over into the 28% bracket which applies to taxable income between $137,050 and $208,850.

Or suppose each party's taxable income for 2009 is $110,000. As single filers, each is in the 28% bracket; as joint filers, they move up to the 33% bracket. The marriage penalty ceases to kick in only when each is in the top bracket of 35 percent--that is, taxable income of more than $372,950, whether they file single or joint returns.

Partial Disallowances of Exemptions and Deductions

Throughout the campaign, there were discussions--with scant elaboration--of other revisions of the Internal Revenue Code. One proposal would restore the phase-out for personal exemptions and the limitation on itemized deductions on Schedule A of Form 1040--provisions that are set to expire at the close of 2009. These cleverly concealed tax hikes first went on the books during the senior Bush presidency and were immediately labeled "stealth" or "backdoor" taxes because they effectively exact more taxes without raising rates. The restorations would boost taxes for individuals with incomes over $200,000 and for families with incomes above $250,000. If the official top rate becomes 39.6%, it would be less than the true top rate of more than 40%.

The current tax code requires most deductions itemized on Schedule A of Form 1040 to be reduced by 1% of the amount by which adjusted gross income (AGI) surpasses a specified figure--adjusted for inflation. For 2009, that amount is $166,800. More specifically, this means that, every $1,000 of AGI above $166,800 results in the loss of $10 in total itemized deductions. The $166,800 figure drops to $83,400 for married persons filing separately. However, going that route does not raise the threshold for a couple to a combined $333,600.

The provision authorizing gradual abolition of stealth taxes has the support of no less than the top officials of the IRS, whose National Taxpayer Advocate said that "the confusing and complex calculations for determining allowable deductions add a significant tax and economic burden to a growing number of taxpayers."

Dependency exemptions start to phase out when AGI surpasses certain levels that are indexed to reflect inflation. For 2009, exemptions must be reduced by 1% of the amount by which AGI exceeds: $166,800 for singles; $250,200 for joint filers; $208,500 for heads of household; and $125,100 for married persons filing separately. All exemptions, including those for a spouse and dependents, vanish when AGI exceeds: $289,300, $372,700, $331,000 and $186,350 for singles, joint filers, heads of household and married persons filing separately, respectively. After 2009, the reductions of itemized deductions and exemptions expire, and unless extended beyond 2009, the 1% will rise to 3% as it was before 2006.

Mind-boggling as the tax law often appears, planners and their clients should heed the advice of Donald C. Alexander, a Washington lawyer (who died Feb. 2) who headed the IRS from 1973 to 1977: "As a citizen," Alexander advised, "you have an obligation to the country's tax system, but you also have an obligation to yourself to know your rights under the law and possible tax deductions. And to claim every one of them."

Julian Block, an attorney based in Larchmont, N.Y., conducts continuing education courses for financial planners. Information about his books can be found at

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