We've been answering this question in a number of different ways to various clients. With the uncertainty about the Bush tax cuts ending this year, one would think estimating your top tax rate is a simple matter of 35% (current) vs. 39.6% (proposed). However, upon close examination, the answer is generally "no difference, even if the higher rates apply!"
One's ultimate tax liability is the higher of two calculations: regular income tax or alternative minimum tax ("AMT"). If you're subject to the top AMT rate of 28%, your tax may not change at all.
Let's assume you're a high income earner (income in excess of $400,000) with capital gains, and also have mortgage expenses, property taxes, charitable contributions and investment expenses. In most cases you'll hit the alternative minimum tax rates.
The following is an example:
|1. Gross income|
|b. Capital Gains||100||100|
|2. Less: Deductions from AGI and Itemized Deductions|
|b. Taxes (property and state income taxes)||50||0|
|c. Charitable Gifts||10||10|
|d. Miscellaneous Expenses||20||0|
|3. Equals: Taxable Income before Exemptions||390||460|
|Ordinary Income Tax||118|
|Alternative Minimum Tax||125|
The AMT catches so many people because substantial deductions are disallowed under the AMT calculation. If you have substantial deductions not permitted under the AMT rules, while your ordinary tax calculation can drop dramatically, the AMT calculation remains static at a high rate of 28%. Accordingly, it may not take huge deductions to push your ordinary tax calculation below the AMT calculation. In the above example, if the ordinary income tax rate increased by 4.6% to 39.6, the increase in tax would not push the $118,000 figure past the $125,000 tax under AMT, so one's taxes would remain the same.
In 2011, if the top long term capital gains rate changes from 15% to 20%, the capital gains tax on $100,000 in both columns will increase by $5,000.
Investors with substantial long term capital gains almost always end up in AMT because the state income taxes are deductible under the regular income tax but not under the AMT calculation.
In the above example, the taxpayer is subject to AMT with the following results:
To return to the question about your top tax rates for 2011, the answer will mostly depend on what makes up your income. For example, the top tax rate on dividends can possibly go from 15% to 39.6% in 2011. Your top tax rates in 2011 could be:
We've all become economists in the last two months, debating whether higher taxes will help or hinder the economy. The real economists are split on this question or prefer to sit on the fence by talking about whether more stimulus is good or bad for the economy.
We've all been abandoned by Congress and the economists. However, we will not do the same. Here is what you need to do given the current uncertainty as things stand today:
Members of the firm recently gave a presentation at the Real Estate Roundtable on various tax structures and strategies for foreign investment in U.S. real property.
The presentation contains additional thoughts on year end planning for foreign investors.
Click here to view the presentation.
Contact Harriet Leung, Partner, Asia Practice if you have any questions.
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