Taxmageddon or Taxpocalypse Now?

The upcoming expiration of the Bush-era tax rates at the end of the year is already starting to produce its share of anxiety along with outsize forecasts of financial disruption.

In recent weeks the term “Taxmageddon” has begun to enter the popular lexicon as observers wonder whether Congress and the Obama administration can possibly get their act together and agree on what to do about the tax rates for next year. Unfortunately, with the elections coming up in November and the heightened political atmosphere that entails, it seems unlikely that any agreement will be forged before November.

That means any real action will have to wait until the lame duck session of Congress, when there is sure to be a frantic amount of activity, with whichever party that wins the general election expecting to have the upper hand. Of course, the losing party is probably not going to be in a very good mood either, and that could mean more obstructionism.

Caught in the middle will be taxpayers and the Internal Revenue Service, which in recent weeks has been practically begging Congress to make up its mind so tax season doesn’t get delayed next year by all the changes in tax forms and schedules that will be required if the current tax rates get changed. After the last extension of the Bush tax cuts, in December 2010, the IRS had to delay the start of the 2011 tax filing season until mid-February. No one, least of all tax preparers, wants that to happen again.

Not only the income tax rates are in question, but also all those tax extenders, along with the alternative minimum tax, the annual patch for which has still not been enacted for this year. Estate taxes, dividend taxes, capital gains taxes and other taxes are set to rise next year unless Congress acts. Popular tax breaks such as the deductibility of state and local taxes, the research and development tax credit and various tuition tax credits also need to be extended.

Congress took up some of those issues in a hearing last week in the House Ways and Means Committee in which the members heard from other members of Congress testifying about their tax extender priorities. However, some Democrats on the committee argued that several of the most needed tax breaks were not even allowed on the agenda. During a different hearing taking place simultaneously in the Senate Finance Committee, an IRS official warned of the consequences of inaction.

But there is plenty of skepticism to go around over whether Congress will be able to decide what to do before the election. President Obama is sticking to his 2008 campaign theme that taxes should not go up on anybody making less than $250,000 a year. On the other hand, he wants to make sure they do go up on anyone making over $250,000 a year. Republicans in Congress have vowed to Grover Norquist they won’t let that happen.

The budget plan introduced by House Budget Committee Chairman Paul Ryan, R-Wis., passed in the Republican-controlled House in March for the second year in a row, but once again is not likely to go far in the Democratic-controlled Senate. Obama’s rival, Mitt Romney, has said he supports the Ryan budget, which would consolidate tax brackets into just two rates of 10 and 25 percent, instead of the current top tax rate of 35 percent. To help pay for lower tax rates on the wealthy and corporations, Ryan’s budget would close tax loopholes, but those are left unspecified in his plan. Ryan also wants to repeal the alternative minimum tax and “broaden the tax base,” which means forcing more lower-income people to pay income taxes.

Romney's own tax plan would lower the top tax rate to 28 percent and the bottom rate from 10 percent to 8 percent. He has called for ending taxation of investment income below $200,000 annually and preserving the current 15 percent rate for dividends and capital gains for taxpayers who make more than that level. Romney has also called for eliminating the AMT and the estate tax.

The Obama administration, on the other hand, wants to impose the so-called “Buffett Rule,” which would impose a minimum tax rate of 30 percent on those making over $1 million. However, legislation instituting the Buffett Rule was blocked in the Senate last month. Obama has also called for making the research and development tax cut permanent, but that too has yet to be decided.

While terms like “Taxmageddon” may seem overblown, the uncertainty about taxes is certainly justifiable. It seems likely that Congress and the Obama administration will decide on a temporary extension again of the status quo at some point, and whoever is in control next year will again take up the perennial question of tax reform. But until they can agree on an extension of the various tax rates and tax breaks, the clock will be running out. All tax practitioners can do is advise their clients of various tax planning scenarios and hope they still make sense next year.

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