Be prepared for a tax cut sunset

(This is an article I submitted to Physicians Practice magazine, an edited version was published.)

With President Obama re-election, there is now no doubt that the Bush tax cuts will expire come January 1^st, 2013.

Why is there a sunset clause in President Bush’s tax cuts?

In 2001 and 2003, Congress passed, and President Bush signed into law, significant tax reductions for nearly all taxpayers. These cuts included marginal rate reductions, the introduction of a new 10% 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 that affects budget deficits beyond a ten-year window, so these tax cuts included a “sunset” provision, which caused them to 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 hike hit.

What does it means for doctors?

The majority of doctors are married, high-income earners with investment assets. They will be hit hard by this expiration. In particular,

• The 28% rate will go up to 31%.
• The 33% rate will go up to 36%.
• The 35% rate will go up to 39.5%.
• The tax rate for long-term capital gains will go back up to 20%.
• There will no longer be a “qualified dividend” category; the tax rate on all dividend income will go back up to the filer’s marginal tax rate.

Does President Obama have an alternative proposal?

Yes, he does. To keep a long story short, his proposal is to keep the tax cuts for those earning less than $250k and let the tax cuts expire for those making $250k and more. Many doctors are making more than $250k, so there will be no relief from Obama.

What doctors can do to limit the tax hit

There are a number of things doctors can do to partially offset the tax increases.

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-turnover index funds, to minimize capital gain realization.

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