Three of the most popular tax breaks showered on Americans by the major tax act of 2003 will start drying up next year unless Congress and President Bush can overcome election-year politicking this fall.
The breaks set to diminish include the $1,000-per-child tax credit and relief from both the marriage-tax penalty and the alternative minimum tax, or AMT. If new legislation is not passed to extend the current tax rules on these provisions, millions of taxpayers will pay billions more in taxes in 2005 than in 2004.
While proposals to continue the tax cuts have broad support among both Democrats and Republicans, the move to extend them is ensnared in election-year gamesmanship. Just before Congress went on its six-week summer break in late July, a bipartisan group of Senators gathered support to grant extension of the breaks for one year.
President Bush, however, apparently wanted to trumpet a five-year extension of these middle-class tax breaks, or wanted the Democrats to oppose them and look bad to voters. And so he balked. And the Democrats didn't want to hand the President a bill he could sign during their convention in Boston. The result: a stalemate until early September.
"These are things that affect a lot of people," says Bob D. Scharin, editor, Warren, Gorham & Lamont/RIA's
Practical Tax Strategies
, a journal for tax professionals. "The people in Congress are aware of these things. The question is what will they do about it and when."
Tom Ochsenschlager, vice president of taxation with the American Institute of Certified Public Accountants, noted that the Senate is determined that any tax cuts must be offset by an equal amount of revenue. And extending these cuts, rather than ratcheting them downward, is costly.
"My guess is this will become an election issue," he says. "You can see where both sides might come out ahead by talking about it and not actually passing it."
So far, the bulk of the election debate has been over income tax brackets and repealing breaks for the wealthiest individuals.
Here's what's at stake:
Child Tax Credit
For tax years 2003 and 2004, families with children who meet certain criteria get a significant tax break -- a credit of $1,000 per child. Unlike a deduction, which is used to offset income, thus reducing the amount of taxable income, a credit is more valuable because it works as either a 1-for-1 reduction against any taxes owed or a refund.
The credit applies to families with children under age 17 and whose income does not exceed certain thresholds (see chart).
The full credit is available to single taxpayers or heads of households with modified adjusted gross income, or AGI, of up to $75,000, married persons filing jointly with AGI of up to $110,000 and married persons filing separately with AGI up to $55,000.
The credit phases out by $50 for each $1,000 or fraction thereof that the AGI exceeds the limits listed above. So a married couple with an AGI of $120,000, for example, would still receive $500 per child.
If the child-tax credit part of the 2003 law is untouched, then the maximum credit will drop to $700 per child annually for the taxable years 2005-2008, then rise to $800 in 2009, increase again to $1,000 in 2010 and fall to $500 in 2011.
Some GOP House leaders had pushed to keep the credit at $1,000 for 10 years -- and to increase the income qualifications on the credit, so that married couples would get the full credit with an AGI of $250,000 and single parents would qualify with an AGI of $125,000. The estimated cost is an extra $228 billion over the decade.
Scharin predicts that the credit's popularity could put the credit extension in some form on the fast track this fall: "It affects so many people, it's more likely to get done than some others."
Marriage Penalty Relief
The "marriage penalty" occurs when the taxes a married couple would pay jointly are more than the sum their tax bills would be if they were paying as two unmarried taxpayers.
The 2003 tax act alleviates some of the disparity for married couples in calendar years 2003 and 2004. For couples taking the basic standard deduction, it is exactly twice the standard deduction for single filers. For couples who itemize, the act increased the size of the 15% tax bracket for joint returns to twice that of the 15% bracket for single filers.
But after 2004, the standard deduction drops to 174% of two single filers, and the 15% tax bracket for married joint filers goes back to 180% of two single filers, as opposed to 200%, which represents parity.
The alternative minimum tax was conceived as a way to ensure that the wealthiest taxpayers with significant tax deductions and loopholes didn't avoid paying income taxes. In recent years, however, the tax -- which is not adjusted for inflation -- has been reaching down into the middle class and becoming a major source of revenue for the Treasury.
Taxpayers with certain triggers, such as high state taxes or high exemptions, must figure both their regular income tax and the alternative minimum tax -- which has different rules -- and pay whichever tax is higher. Under the AMT, taxpayers are allowed to take an exemption that helps reduce their taxes.
Under the 2003 tax act, taxpayers got some relief from the AMT when the exemptions for 2003 and 2004 were raised: to $58,000 for married persons filing jointly, to $40,250 for single filers and heads of households, and to $29,000 for married persons filing separately. (Note that this structure has a marriage penalty of its own.)
Unless the law is changed, the exemptions will drop sharply in 2005, to $45,000 for married persons filing jointly, $33,750 for singles and heads of households and to $22,500 for married individuals filing separately.
"More people will be snared by the AMT," says Scharin. "The AMT was not supposed to affect so many taxpayers. It was meant to affect tax-sheltered investments, things that wouldn't pass the smell test. It's kind of the stealth tax."
And one that critics say should be restructured or eliminated altogether. In the meantime, relief is all taxpayers can expect -- and you can expect some voters to factor that in to their decision in November.
Before joining TheStreet.com, Ann Perry was the personal finance columnist for The San Diego Union-Tribune. She is the author of "The Wise Inheritor: A Guide to Managing, Investing and Enjoying Your Inheritance" (Broadway Books, 2003). She has a B.A. in English and Communications from Stanford University and a master's degree from the Columbia University School of Journalism. She can be reached at