Tax cuts: Where the fight stands now

Democrats will control the House, and may well control the Senate. Here's what that might mean for your taxes.

By Jeanne Sahadi, senior writer

NEW YORK ( -- Whenever the balance of power shifts in Washington, the question arises: "Will taxes go up?"

In their campaign for House and Senate seats this fall, Republicans were asserting that under a Democratic majority on the Hill, that's exactly what would happen.

Now that the Democrats are set to control the House in 2007 and possibly the Senate as well, tax-cut policies and proposals championed by the Republican-led Congress may be subject to some revisions, or at the very least debates.

But the tax and political experts that consulted Wednesday predict that in the next two years anyway the Democrats are unlikely to make any major tax moves that would increase taxes or otherwise unravel President Bush's tax cuts, which are set to expire at the end of 2010.

That's because there will be an emphasis on pragmatism. Democrats will be eager to preserve their majority in 2008 and maintain a fair shot at winning the White House. Plus, there's the likelihood that President Bush would veto any repeal of his tax cuts.

Here's a breakdown of the experts' predictions about the course lawmakers will take in the next two years on several major tax issues:

Capital gains and dividend tax

This year lawmakers extended through 2010 the 15 percent rate on long-term capital gains and dividends. For low-income taxpayers, that rate will be 0 percent.

After 2010, the rates are scheduled to revert to 20 percent for long-term capital gains - 10 percent for those in the lowest tax bracket - and for dividends.

Greg Valliere, chief political strategist for the Stanford Group, a Washington research firm; Clint Stretch, managing principal of tax policy at Deloitte Tax LLP; and Chris Edwards, director of tax policy at the libertarian Cato Institute all said they predict those rates will remain untouched through 2008.

Valliere noted that given the presidential elections in 2008, it's unlikely anything significant would happen in the first half of 2009. Edwards added that even if a Democratic president won office in 2008, the Democrats might feel pressure to extend the lower investment tax rates if there threatens to be a bad reaction from Wall Street.

AMT relief

All three experts also agreed that Congress would pass AMT relief for 2007. That relief - an increased exemption amount designed to keep the "wealth" tax from hitting middle-income families - is already in place for tax year 2006. Congress will have until April 2008 to extend that increased exemption amount for tax year 2007.

The AMT imposes a higher bill on taxpayers than the regular tax code.

The tax, originally intended for the wealthy, now threatens to catch tens of millions of middle-class taxpayers unless lawmakers continue to increase the AMT income exemption levels, since the original levels were never adjusted for inflation.

For tax year 2006, the AMT income exemption levels are $42,500 for single filers, up from $40,450, and $62,550 for joint filers, up from $58,000.

In addition, when calculating whether they're subject to AMT, taxpayers will be allowed to use all nonrefundable personal credits to offset AMT liability. Normally, these credits often end up being disallowed under AMT.

Estate tax

Republican-supported repeal is off the table for the next two years, but a compromise reform such as an increase in the exemption level may be possible, all three Washington observers said.

"Some permanent estate tax compromise could be a sweetener to legislation Republicans would object to," Stretch said.

But there could be a struggle over what to do about the top estate tax rate, Edwards and Valliere said. Currently, estates that exceed the exemption level of $2 million are taxed in a graduated manner with rates starting at 18 percent and rising to 46 percent. That top rate will revert to 55 percent in 2011 unless the law is changed.

Many Democrats have been amenable to raising the exemption level -- including Charles Rangel (D-NY), the next chairman of the powerful House Ways and Mean Committee. The exemption level increases to $3.5 million in 2009, but will fall to $1 million in 2011, after a one-year repeal of the tax in 2010.

Far fewer Democrats have favored reducing the estate tax rates as much as Republicans, who don't want a top estate tax rate higher than 30 percent.

Since the estate tax won't be reinstated at its higher levels until 2011, "nothing has to be done until 2010," Edwards said.

Making income tax reductions permanent

Edwards predicts if the Democrats are in charge they may allow the reduced top income tax rates to expire.

But Stretch noted that they are likely to make permanent the 10 percent income tax rate, the increased child tax credit and increased marriage penalty relief, all of which were part of tax relief legislation passed since 2001.

Tax extenders

Stretch and others think it's likely that Congress this year will pass a number of promised tax break extenders excluded from the tax relief bill passed this spring.

Key among them are the research and development credit for businesses, a deduction for college tuition and a welfare-to-work credit.


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