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Obama’s Proposed Budget May Not Have The Tax Effect You Were Anticipating

For all the clamor and criticism over the proposed tax increases included in President Barack Obama’s 2013 fiscal year budget, there is likely to be little or no effect on federal tax payments made by many of the millions of Americans who earn between $200,000 and $1 million annually.

This is especially true for those who live in or near major cities, and already pay high state and local taxes.

Obama’s budget, if passed as is (which is questionable in the highly charged political atmosphere of a presidential election year), was designed to ensure the very rich pay federal income tax at a rate of at least 30%, while lowering tax rates for the middle class.

It calls for the elimination of the Alternative Minimum Tax (AMT), the creation of the “Buffet Rule,” and the expiration of the Bush era tax cuts at the end of 2012 for those earning more than $250,000 annually.

The Buffet Rule would implement a higher minimum tax rate and tax certain benefits for taxpayers at the highest income level to ensure everyone making more than $1 million pays a minimum effective tax rate of at least 30%.

The expiration of the Bush era tax cuts for those in the higher income brackets means that households making more than $250,000 and individuals making more than $200,000 would see their marginal income tax rate increase from 35% to potentially 39.6%.

While the Buffet Rule could certainly have a dramatic impact on those earning more than $1 million, the expiration of the Bush era tax cuts may not have the same effect on those earning between $200,000 to $1 million, due to the offsetting effect of the AMT.

People who fall under the AMT pay an effective 28% tax rate, which is created by limiting certain deductions. Under the AMT, deductions for state and local taxes, miscellaneous itemized deductions, interest expense and even the deduction for personal exemptions are limited until the individual’s effective rate is raised to 28%.

Even if the AMT was kept in place, as is, a raise in ordinary rates may not have a dramatic effect on the tax one ultimately pays.

Why? Because high-income earners are currently not able to take advantage of tens of thousands of dollars in deductions under the AMT if they live:

  • in high tax states (California and New York, among others).
  • in cities that also levy their own income taxes (New York City, Philadelphia, Cleveland).
  • in areas where real estate/property taxes are significant.

For people who are high AMT payers, the raising of ordinary rates, combined with the elimination of the AMT, will merely allow the previously disallowed deductions to be taken against ordinary income, which will have the net effect of reducing the tax back down to the 28% effective rate.

High income earners will still not be able to deduct all their itemized deductions as the proposed budget would place limits on such deductions and only allow them to reduce taxes to the 28% effective rate.

How many people fit into this category?

Consider that the Alternative Minimum Tax should ensnare as many as 4.8 million individuals this year, according to the Tax Policy Center in Washington. Without temporarily raising the AMT exemption, which Congress has done each of the last several years to account for inflation, that 4.8 million figure could balloon to 31 million in 2012.

In this election year, it is hard to predict what parts of the proposed budget, if any, will eventually get passed. But for those that thought Obama’s budget would be unforgiving to the wealthiest among us, the numbers could reveal a very different story.

Alan G. Badey is the managing partner of Citrin Cooperman’s White Plains, N.Y. office. Citrin Cooperman is a full service accounting and consulting firm.

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