Unless the lame duck Congress extends the Bush era tax provisions, they will expire at December 31, 2012. This reflects the “Sunset” aspects of the tax laws, or to put it another way, these tax reductions had a limited life. These tax rate reductions were originally passed in 2001 and 2003

Higher Tax Rates

Not only the top two brackets will be higher. The existing 10% bracket will go away, and the lowest “new” bracket will be 15%. The current 25% bracket will be replaced by a 28% bracket; the existing 28% bracket will be replaced by a 31% bracket; the existing 33% bracket will be replaced by a 36% bracket; and the current  35% bracket will be replaced by the 39.6% bracket.

Higher Capital Gains and Dividends Taxes

In 2012  the federal rate on long-term capital gains and dividends is 15%.  Beginning in 2013, the maximum rate on long-term gains will increase to 20% (or 18% on gains from assets acquired after Dec. 31, 2000, and held for over five years), and the maximum rate on dividends will increase to 39.6% (dividends will be taxed at one’s ordinary income rate) .

Harsher Marriage Penalty

The ‘marriage penalty’ may cause a married couple filing jointly to pay more in taxes than when they were single. The Bush tax cuts included several provisions to ease the so-called marriage penalty.

At present, the lowest two tax brackets for married joint-filing couples are exactly twice as wide as for single filers. This  keeps the marriage penalty from affecting the tax liability of lower and middle-income couples. In 2013, the joint-filer tax brackets will contract, causing higher tax bills for many folks.

Currently, the “standard deduction” for married joint-filing couples is double the amount for singles. Starting next year, the joint-filer standard deduction will fall back to about 167% of the amount for singles.

Return of Phase-Out Rule for Itemized Deductions

Before the Bush tax cuts, a phase-out rule could take away up to 80% of a higher-income individual’s itemized deductions for mortgage interest, state and local taxes, and charitable donations. This restriction  was eliminated in 2010.  In 2013, however, the phase-out will be back when the Bush cuts expire.

Return of Phase-Out Rule for Personal Exemptions

Before the Bush tax cuts, another phase-out rule could eliminate some or all of a higher-income individual’s personal exemption deductions (for 2012, personal exemption deductions are $3,800 each). The restriction was also eliminated in 2010. When the Bush cuts expire, it will be back next year.

What May Happen in the Remainder of the Year 2012.

The increase in the Federal capital gains rate from 15% to 20%, effectively a 33% increase, should encourage taxpayers and their advisors to make an inventory of highly appreciated securities, and consider selling many of their security positions. Even if you believe that a particular stock is worth holding for the long run, it may be practical to sell it for a capital gain in 2012 at the lower tax rate, and reinvest part of your proceeds in the same security.

There is significant pressure by shareholders of companies with cash balances greater than current working capital needs to pay extra dividends this year. Higher bracket taxpayers may face an increase in their dividend tax rate from 15% to 39%, more than a 100 increase !

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