The Expiration of Bush-era Tax Cuts: Increase in Capital Gains and Dividends Tax Rates

Under the current law, the reduced tax on long-term capital gains and qualified dividends are scheduled to revert in 2013 to their pre-2003 levels. For the past ten years, taxpayers in the 10% or 15% tax bracket did not have to pay federal income tax on long-term capital gains. Individuals in higher tax brackets incurred a 15% tax on long-term capital gains. Additionally, qualified dividends have been taxed at the reduced capital gains rates.

Assuming Congress does not extend these tax cuts, long-term capital gains will be taxed at 10% for taxpayers in the 15% tax bracket. Individuals in a tax bracket above 15% will be taxed at 20% on their long-term capital gains. Investment decisions should not be made solely for tax purposes. However, if a taxpayer is expecting to incur large capital gains or make substantial sales, they may want to consider completing the transactions in 2012 rather than waiting until 2013.

Furthermore, absent any extension, qualified dividends will be taxed at ordinary income tax rates instead of capital gains tax rates. The highest individual income tax rate is scheduled to be 39.6% after 2012 while the highest capital gains rate is expected to be 20%.

The higher rates on capital gains and dividends would increase marginal tax rates on capital income for high-income taxpayers and could reduce private saving. Qualified corporations may want to consider declaring a special dividend to shareholders by December 31, 2012 to take advantage of more favorable tax rates.

Due to the 2013 tax laws still in limbo, Anders CPAs and consultants will be following the progress in Congress. In the meantime, please contact your tax advisor for any questions related to the expiration of Bush-era tax cuts.