Yeah, I'm the taxman.
Should five per cent appear too small,
Be thankful I don't take it all.
-The Beatles, Taxman, 1966

For most of us, the idea of higher taxes is anathema. In fact, we have been living in a golden age of taxation since President Ronald Reagan lowered taxes nearly a quarter of a century ago.

Well, let's all have a moment of silence for the end of an era. Taxes will rise. You can bet on it.

The first step in that direction comes in the form of sweeping health care legislation: the Patient Protection and Affordable Care Act, along with its amendment, the Health Care and Education Reconciliation Act of 2010, signed into law by President Barack Obama earlier this year.

While a lot of the specifics remain to be determined, it seems to be an opportune time to provide a brief overview of the act's terms and offer some initial thoughts about the impact on investors. We will also review certain other measures being considered that may affect investment and wealth management strategies. Keep in mind that because of the Bush tax reforms, the tax code has become a collection of expiring provisions. So advisors and investors need to stay apprised of the many changes expected over the coming year.

Funding Health Care
To fund health care reform, beginning in 2013, a 3.8% surcharge tax will be assessed on investment income such as interest, dividends, rents and capital gains. This surcharge applies to individuals with adjusted gross incomes above $200,000 and couples above $250,000. The legislation also raises the ordinary Medicare payroll tax by 0.9% for the same filers, bringing it to 3.8%. Interest income from municipal bonds is excluded from the new Medicare tax.

Goodbye, Bush Tax Cuts
President George W. Bush enacted a number of changes to the tax system that resulted in lower taxes across the board-most notably, lower marginal tax rates, lower rates on dividends and capital gains and higher thresholds to assess estate, gift and generation-skipping transfer taxes. However, a sunset provision means that all of these changes will expire at the end of 2010.

The federal government is not required to do anything to increase taxes in 2011 since taxes will automatically return to pre-2001 rates. That means, for example, that the highest marginal tax bracket will return to 39.6% and the long-term capital gains tax will be 20% instead of the current 15%. Qualified dividends, however, may be capped at 20%.

Also in 2001, the estate and GST exemptions were each at $1 million and the top estate, gift and GST tax rate was 55%. There have been proposals in Congress to freeze the estate and GST tax exemptions at the 2009 levels of $3.5 million for each individual or $7 million for married couples, and to keep the maximum estate, gift and GST tax rate at 45%.  There are some other ideas being discussed, such as extending the alternative minimum tax exemptions adopted for 2009 and indexing them to inflation.

Ultimately, the top federal marginal tax rate affecting income and short-term capital gains will climb to 43.4% in 2013 when combining the federal tax rate and the Medicare surcharge. Add in state tax rates and, needless to say, high-income taxpayers are going to experience a big jump in their tax bills.

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