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The end of the Bush-era tax cuts is likely on the horizon. Here's what it means for physicians and how they can begin preparing today.
With President Barack Obama's re-election, there is now no doubt that the Bush Tax Cuts will expire as of January 1, 2013.
Why is there a sunset clause in President Bush’s tax cuts?
In 2001 and 2003, Congress passed, and President George W. Bush signed into law, significant tax reductions for nearly all taxpayers. These cuts included marginal rate reductions, the introduction of a new 10 percent tax bracket, an expansion of the child tax credit, and a variety of other provisions. Both bills were passed using a Senate procedure known as "reconciliation" - a tactic that lowers the threshold for cloture to a simple majority of Senators (as opposed to a 60-vote supermajority.)
This procedure, under the Congressional Budget Act, is not allowed for any bill which affects budget deficits beyond a 10-year window, so these tax cuts included a "sunset" provision which caused them to automatically expire at the end of 2010, in order to bypass that requirement.
The sunset of the Bush tax cuts were extended by President Obama twice to the end of 2012, largely because the economy was in the tank and could not take another tax hit.
What does this mean for physicians?
The majority of physicians are married, high-income earners with investment assets. They will be hit particularly hard by this expiration. In particular:
• The 28 percent rate will go up to 31 percent.
• The 33 percent rate will go up to 36 percent.
• The 35 percent rate will go up to 39.5 percent.
• The tax rate for long-term capital gains will go back up to 20 percent.
• There will no longer be a “qualified dividend” category; the tax rate on all dividend incomes will be back up to the filer’s marginal tax rate.
Does President Obama have any alternative proposal?
Yes he does. To keep a long story short, his budget proposal is to keep the tax cuts for those earning less than $250,000 and let the tax cuts expire for those making $250,000 and more. Many doctors are making more than $250,000, so there will be no relief from the president's plan.
What can doctors do to limit the tax hit?
1. Explore the option of using a defined benefit plan to create a substantially larger tax deduction.
2. Explore the option of low-cost, non-commission variable annuities to shelter capital gains and investment incomes from taxation.
3. Use tax-efficient investment vehicles like low-turn over index funds to minimize capital gain realization.