SO, WE AVERTED THE FISCAL CLIFF, NOW WHAT?
In the last 2 weeks, we have survived the Mayan Apocalypse and the dreaded Fiscal Cliff as we watched 2012 draw to a close. So what does it all mean? Well, since we all survived the end of the Mayan calendar, the world as we know it will carry on. But what does surviving the Fiscal Cliff mean to most of us, besides finally putting an end (at least for now) of those stupid countdown clocks on TV? I say for now, because, we will likely be held hostage by our friends in Washington as they try to negotiate a deal on the National Debt Ceiling, which we will reach in a couple of months if an agreement cannot be reached. The Debt Ceiling could end up causing more consternation than the fiscal cliff, as Republican’s seem determined to dig in their heels to get the spending cuts they want enacted.
By avoiding that hit and finally nailing down numerous features of the tax code, the deal lifts a cloud that had hung over the economy and investor confidence. But on almost every other point, the deal falls short of already low expectations. It leaves in place significant short-term austerity while doing nothing to change the long-term trajectory of debt. It doesn’t reform taxes or entitlements. And it doesn’t deal with several key components of the cliff.
The main elements of the fiscal cliff were the expiring Bush tax cuts; expiring extended unemployment insurance benefits; an expiring payroll tax cut; automatic spending cuts worth $110 billion per year, spread equally across defense and domestic programmes (called a sequester); and the debt ceiling, the statutory limit on how much the Treasury must borrow, which was reached on Monday.
The current deal covers only the Bush tax cuts and enhanced unemployment-insurance benefits, which will continue for one more year. The payroll-tax cut will expire as scheduled, sapping workers’ purchasing power by roughly $1,000 each. Together with the higher taxes on the rich, that will impose a significant fiscal drag on the still-fragile recovery early in 2013.
The sequester was due to take effect this week. That will be delayed for a few months. The White House has discretion to backload some of the cuts for now, in hopes of a negotiated delay or replacement. But the Pentagon has already warned some of its 800,000 civilian employees of furloughs, and contractors who do business with the federal government may start to lay workers off.
– Source, “The Economist Free Exchange Blogs” –http://www.economist.com/blogs/freeexchange/2013/01/fiscal-cliff-deal
So, what do the new tax laws that were signed into law by President Obama on January 2, 2013 mean for most people? Let’s take a look at several of the major issues addressed by what is being called the “American Taxpayer Relief Act of 2012”. Since these major tax acts usually are known by their acronym, this will probably be known in the future as ATRA 2012. There are several other provisions for individuals and businesses that are not mentioned here, but if you would like to read the whole Act, the Government Printing Office has the whole thing. Enjoy!
No Extension of the 2% Payroll Tax Cut
Probably the part of the new tax law that affects the most people, especially those that are working, is not really a change in the tax law, but rather, not extending the 2% Social Security (FICA) payroll tax “holiday” that started in 2011. Prior to 2011, employees paid 6.2% of their wages and their employer matched 6.2% to be paid into FICA, on earnings up to a certain limit ($113,700 in 2013) that is adjusted for inflation each year. For 2011 & 2012, the employees’ rate was cut to 4.2% as a temporary payroll tax “holiday”. This was done to help spur growth in a slow economy and was not designed to be permanent.
For someone making $100,000 a year from employment, this saved $2,000 a year in taxes (or $83.34 a paycheck if paid twice a month). Now, that the rate is headed back up to 6.2% again, it is essentially a tax increase of $2,000, which will likely have some impact on the growth of the economy. . So, yes, you can call this a tax increase, but you could also call it an expiration of a temporary tax cut, take your pick.
Capital Gains & Qualified Dividends
Another area of ATRA 2012 that had a lot of people worried was what would the rates on long term capital gains and dividends rise to? If nothing was done and the Bush tax cuts that created these rates were allowed to expire, than long –term capital gains would increase to 20% for everyone, and qualified dividends would be treated as ordinary income and would not get the special 15% tax treatment. Well, if your income is under $400,000 for singles and $450,000 for couples, you will not see any change, as the rate will remain at 15% for these income sources, since the Bush tax cuts were made permanent for these income levels. If you are in the 10% or 15% federal tax bracket, these will be taxed at 0% like they have been since 2008.
However, if you are considered a “high income” taxpayer with income above $400,000 for singles and $450,000 for couples, your rate jumps to 20% on long term gains and qualified dividends. Plus, your investment income (capital gains, dividends, interest, rental income) may be subject to a 3.8% Medicare Tax surcharge due to the Obama Care legislation. You may fall into the Medicare surtax if your Adjusted Gross Income (AGI) exceeds $200,000 for singles or $250,000 for couples.
Changes in Federal Income Tax Brackets
For those of you that are not considered “high income” taxpayers your Federal Tax rates will stay roughly the same, except for inflation indexing. The only tax bracket that is increasing is the highest income tax bracket, where the marginal rate will be increasing from 35% to 39.6%. The marginal rate is the rate at which your last dollar of income is taxed at. So if you are single and have taxable income of $400,001, only $1 is in the highest tax bracket. All your other income up to $400,000 would be taxed at the rates below for the appropriate taxable income amounts.
|Rate||Single Filers||Married Joint Filers||Head of Household Filers|
|10%||$0 to $8,925||$0 to $17,850||$0 to $12,750|
|15%||$8,925 to $36,250||$17,850 to $72,500||$12,750 to $48,600|
|25%||$36,250 to $87,850||$72,500 to $146,400||$48,600 to $125,450|
|28%||$87,850 to $183,250||$146,400 to $223,050||$125,450 to $203,150|
|33%||$183,250 to $398,350||$223,050 to $398,350||$203,150 to $398,350|
|39.6%||$400,000 and up||$450,000 and up||$425,000 and up|
Alternative Minimum Tax – AMT – “Patched” Permanently
This is actually a very big deal. The Alternative Minimum Tax (AMT) was implemented in 1969 to catch a handful of very wealthy taxpayers who did not pay any income tax. It is a parallel tax calculation that disallows certain exemptions and then assesses a lower marginal tax rate. If the AMT is higher than the Federal income tax, then the taxpayer pays the higher AMT. The problem was, though, that the AMT exemption amount was set decades ago and was supposed to be high enough to miss most of the middle class. But the level was never indexed to inflation, so now many years later up to 28 million families may have had to pay up to an additional $3,000 or so in extra taxes if something was not done. For the last several years, a last minute “patch” was implemented that inflation adjusted the exemption amount, and saved many middle class people this extra tax. ATRA 2012, permanently inflation indexes the AMT exemption, so we won’t have to wait each December for a last minute “patch” to save many a hefty tax increase. Bravo!
Estate & Gift Taxes
For the last couple of years many people were worried that the $5million exemption per person would be reduced to possibly $3.5 million, or even worse, revert back to $1 million per person. But Congress came through and made the $5 million per person exemption permanent. This means that we won’t have to worry every couple of years about the tax rate expiring. Also, the ‘portability’ provision was made permanent. This allows the longer living spouse to use, at their death, any unused exemption amount that their deceased spouse did not use. So a couple essentially has $10 million in exemptions to utilize. The exemption is actually going to be indexed for inflation in the future as well, so the 2013 exemption amount is actually $5.25 million per person.
However, the estate tax rate on amounts over the exemption amounts have been raised from 35% to 40%. Since, the $5 million exemption was more than most had hoped for, the tax rate rise is a minor issue except for the ultra-wealthy. The nice thing (except for attorneys) is that estate plans that were written based on the laws in the last couple of years will not need to be redone.
On another note, the annual gift exclusion (or the amount you can give someone without gift tax consequences) will rise to $14,000 per person in 2013. This was not actually part of the new tax act and was already set to take place.
Itemized Deductions Limitations (Pease)
For higher income taxpayers that itemized their deductions on Schedule A, these deductions have been reduced by a certain amount that the taxpayers AGI is above a certain threshold. This limitation was known as the “Pease” limitation, named after the Democratic Representative from Ohio that introduced this legislation back in 1991. For 2011 & 2012, this limitation was repealed, but with ATRA 2012, the repeal was lifted for singles with AGI above $250,000 and couples above $300,000. Taxpayers above these income limits can lose up to 80% of their itemized deductions depending on how high their income is. People under these income levels do not have to worry about their itemized deductions being reduced.
Personal Exemption Phase-out
Similar to “Pease”, for years, taxpayers with AGI above certain limits would also have their personal exemptions phased out. This was also repealed for everyone in 2011 & 2012. For taxpayers with the same income levels as “Pease”, ATRA 2012 reinstates the phase outs.
Roth Conversions of Retirement Plans While Still Employed
ATRA 2012 allows you to roll over funds in a company sponsored retirement plan such as a 401k to a Roth IRA while still employed. Prior to the new law you could only make this kind of rollover to a Roth IRA from a 401k if you had left employment of the employer that sponsored the plan. You will now be able to do an in-service roll over to a Roth IRA without having to quit or retire. However, you will be required to pay the tax due on conversion from other funds. So, in order to do a conversion, you will need to have the money available from outside the plan that is being converted. Still, this is a great provision for those who have been looking to convert some of their 401k balance to a Roth.
Required Minimum Distribution to Charity
Since 2006, IRA owners that are 70 ½ or older have been able to make a qualified charitable distribution (QCD) of up to $100,000 of their Required Minimum Distribution (RMD) each year when made directly to a charity. The amounts are not included as an itemized deduction, but they are also not included as income. With the new tax laws, keeping income down for many people will be a prime concern, so for the charitably inclined this is a great deal.
Since this originally was not going to be allowed in 2012, the law allows an individual that took their RMD in December 2012 to send a contribution in any amount up to $100,000 (limited by the amount of the RMD taken in December 2012) to charity. This contribution will be treated as if it had been sent directly to the charity for 2012 and will not count as 2012 income or charitable deduction. You essentially have an extra month to reduce your taxable income if you fall into the category of someone that took all or part of their RMD in December 2012. Unless extended again, this provision is set to expire again at the end of 2013.
American Opportunity Tax Credit (AOTC)
This credit allows taxpayers with AGI under $80,000 for singles & $160,000 for couples to claim a credit equal to 100% of the first $2,000 of qualified tuition and related expenses, plus 25% of the next $2,000 of qualified expenses.
This would result in a maximum tax credit of $2,500 for the first four years of post-secondary education. This credit has been extended through 2017 much to the relief for those sending their kids to college the next couple of years.
Other Various Extensions
The following is a list of various provisions that were extended by ATRA 2012.
• The deduction for certain expenses of elementary and secondary school teachers, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The student loan interest deduction is permanently extended. ATRA eliminates the rule that the deduction can be claimed only during the first 60 months of repayment.
• The treatment of mortgage insurance premiums as qualified residence interest, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The option to deduct State and local general sales taxes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013.
• The above-the-line deduction for qualified tuition and related expenses , which expired at the end of 2011 and which is now revived for 2012 and continued through 2013; and
• The child tax credit remains unchanged and is permanently extended. The maximum amount of the child tax credit is $1,000, and the credit is partially refundable. However, the provision that reduces the earnings threshold for the refundable portion of the child tax credit to $3,000 will expire at the end of 2017.
• The dependent care tax credit remains unchanged and is permanently extended. Daycare expenses up to $3,000 for one child and $6,000 for two or more children qualify for the tax credit, and these amounts are not indexed for inflation.
• The adoption credit is permanently extended. The credit is worth up to $10,000 (indexed for inflation).
• Also permanently extended is the earned income tax credit for families with three or more dependents
Non Tax Items
Finally, a list of some of the non-tax items addressed in the new legislation:
- The sequester will be delayed for two months. Half the cost of the delay will be offset by discretionary cuts, split between defense and non-defense. The other half will be offset by revenue raised by the voluntary transfer of traditional IRAs to Roth IRAs, resulting in a tax retirement savings when they’re moved over.
- The pay freeze on members of Congress, which Obama had lifted this week, will be reinstated. C’mon, they earned it didn’t they?
- Scheduled cuts to doctors under Medicare would be avoided for a year through spending cuts yet to be identified.
- Federal unemployment insurance will be extended for another year, benefiting those unemployed for longer than 26 weeks. This $30 billion provision won’t be offset.
All in all, most people will feel at least some effect of ATRA 2012. Those considered “high income” taxpayers will feel the greatest effects. However, for everyone else, the effects will not be as great as many had feared. Now, the country will turn its attention to Washington in a couple of weeks, as the debate over the “Debt Ceiling” will take shape. This promises to be another epic battle between Republicans and Democrats, as entitlement spending and reducing the national debt are top priorities that the Republicans are likely to push harder for, now that they have given up some rope on tax increases.