The Tax Code’s Day of Reckoning: January 1, 2011

Lawmakers this week agreed to extend the special lowered tax rates on capital gains and dividends until 2011. If their agreement becomes law, it may turn January 1, 2011 into what the Washington Post calls “The Day of Reckoning.” From yesterday’s Washington Post:

With this week’s hard-fought agreement on a $70 billion tax-cut extension, President Bush and congressional Republicans have effectively set a date for a fiscal day of reckoning for the next president and a future Congress: Jan. 1, 2011.

House and Senate negotiators reached agreement this week on legislation to extend the deep tax cuts on capital gains and dividends beyond their scheduled 2008 expiration date, through 2010. Final passage of the agreement must wait until Republican tax writers agree on a second tax bill that includes many of the tax breaks jettisoned from the measure on capital gains and dividends. If the deal wins congressional approval, every major tax cut passed in Bush’s first term will be set to expire on the same day five years from now.

Here’s a list compiled by Tax Foundation staff of major federal tax changes that will occur in 2011 if this package is enacted, on the unlikely assumption that everything else remains unchanged:

• Individual income tax rates go from 10%, 15%, 25%, 28%, 33%, and 35% to 15%, 28%, 31%, 36%, and 39.6%.

• Child credit falls from $1,000 per child to $500 per child.

• Capital gains tax rates would revert back to 10% and 20% (depending on AGI), while they are currently at 5% and 15%.

• Dividends would once again be taxed at the ordinary income rates (see above), while today they are currently at 5% and 15%.

• After being fully phased out for tax year 2010, the estate tax would be fully reinstated with a top rate of 60 percent and a $1 million exemption.

Of course, the best solution is for lawmakers to not focus solely on these expiring tax provisions, but rather to focus on fundamental tax reform, moving toward a tax code that’s less complex and less distortionary. The final report of the President’s tax reform panel last November is an excellent starting point.