WASHINGTON Democrats are postponing a vote on renewing Bush-era tax cuts until after the November elections, when Republicans may gain several congressional seats immediately.
Tax rates for all Americans, including top rates for dividends and capital gains, rise unless Congress acts by the end of this year.
Here's a look at how things could unfold once Congress reconvenes and tackles the tax cuts post-election in what is known as a "lame duck" continuation of the current session.
Although the newly elected Congress does not convene until January, Republicans could gain four Senate seats right away due to vacancies this year.
EXTEND "MIDDLE CLASS" RATES; TOP RATES FOR SHORT TERM
Nearly all Democrats and Republicans agree on one thing: they want to extend tax rates for what Democrats call the "middle class" and under, defined as the first $200,000 of an individual's income, or $250,000 and under for families.
The sticking point is what do for income above those levels.
Republicans say extending lower rates for that group will boost the economy; Democrats say that group is unlikely to spend cash immediately to jumpstart the recovery.
The most likely scenario may be a permanent extension of lower rates for the middle class and under, coupled with a temporary extension of the lower rates for wealthier Americans.
Some conservative Democrats and some Republicans have pitched such a compromise where the lower taxes for upper income groups -- about 3 percent of the population -- would be extended for a year or two.
The Republican position was boosted when two respected economists, former White House budget director Peter Orszag and Moody's economy.com chief economist Mark Zandi, recently said that the most feasible option politically is to extend all the rates, not just those for the middle class.
Both noted that option is more feasible because of Democrats' slim majority and Republicans' willingness to fight alternative proposals.
EXTENSION ONLY FOR THE MIDDLE CLASS
A limited extension only for the middle class is seen as a less likely option.
Senate Democrats had expected a vote to limit the tax cut extension to the middle class and under would be a winning position heading into the November races.
Most polls show Americans back that policy.
But Democrats' majority of 59 Senate seats still falls below the 60 votes to push this proposal over procedural hurdles thrown up by Republicans. And their position was further eroded when some Democrats in tight races, sided with Republicans, citing the iffy economy.
Further, the November election could change the Senate makeup immediately.
Republicans could gain as many as four vacant seats, cutting the Democrats majority from 59-to-41 to 55-to-45 seats, and making it more difficult for the Democrats on taxes.
EXPIRATION OF ALL RATES
Although many predict a post-election deal, the parties could fail to reach an agreement, leading to a situation where nearly everyone's taxes go up January 1. That would help plug a hole in the budget deficit but could stifle economic growth and be damaging to politicians seen as backing tax hikes.
"It's essentially going to be this game of chicken and there is a good chance that neither side blinks," said Chris Krueger of Concept Capital, a private firm that tracks Washington for institutional investors.
Rates could be lowered after the new year retroactively but that wouldn't hurt the initial sting of higher taxes.
It would also create an administrative nightmare for the government and individuals.
"There will be more egg on the face of Democrats if a deal isn't done because they are in control," Krueger added.
DIVIDENDS, CAPITAL GAINS, ESTATE TAXES
A compromise likely would weave in side deals on capital gains, dividends and estate taxes.
Taxes on dividends and capital gains will also rise if Congress takes no action. Obama and most Democrats want to raise the rates from 15 percent to 20 percent for high earners. Republicans want to keep the rates at 15 percent.
A complicating factor: if Congress does not act, tax rates on dividends in 2011 will rise to ordinary income rates, which would mean a top rate of 39.6 percent.
Mark Bloomfield, president of the American Council for Capital Formation, a group of companies fighting higher investment expects some sort of extension of all the individual and investment tax rates.
"It looks like a temporary reprieve from a hanging," he joked.
Some who worry about all the lower tax rates expiring point to the expiration of the estate tax last year, which caught nearly all analysts off guard, after Republicans blocked a Democratic plan to extend the 2009 rates.
The estate tax -- which mainly affects the wealthy -- is reinstated next year automatically with higher-than-2009 rates if Congress doesn't act.
"I think this is different: it will affect a lot more people," Bloomfield said. "That is the big difference."
(Additional reporting by Thomas Ferraro; Editing by Jackie Frank)