Tax Consequences of the Fiscal-Cliff Deal
posted Jan 4, 2013 by Paul Oliveira, CPA
On January 1st, 2013, the Senate and House of Representatives passed a bill designed to avert wide-ranging tax increases and budget cuts scheduled to start with the new year. The bill, expected to be signed into law by the President, will raise taxes by approximately $600 billion over 10 years.
The bill also delays for two months mandatory budget cuts to the Pentagon and other federal agencies. The bill would prevent many of the tax hikes that were scheduled to go into effect this year while keeping many favorable tax breaks that were scheduled to expire at the end of 2012. At the same time, the bill increases income taxes for some high-income individuals and slightly increase transfer tax rates. This is an overview of the bill’s main provisions. Key elements of the bill include:
Tax relief extension and tax increases:
Permanently extend tax rates for most Americans. For tax years starting after 2012, the income tax rates for individuals will stay at 10%, 15%, 25%, 28%, 33% and 35% (instead of moving to 15%, 28%, 31%, 36% and 39.6% as would have occurred under the 2001 “Bush Tax Cut” sunset).
Higher tax rates for highest earners. The bill raises the top tax rate to 39.6% rate for joint filers earning $450,000, heads of household earning $425,000, single filers earning $400,000. These dollar amounts are indexed for inflation. The takeaway here is that the “Bush Tax Cut” rates remain unchanged for everyone with income below the $400,000/$425,000/$450,000 thresholds.
Personal Exemption Phase-out (PEP) limits apply to high-earners. Personal exemptions exempt a certain amount per person from tax. For tax years beginning after 2012, the (PEP), which was previously suspended, is reinstated. The PEP applies to joint filers earning $300,000, heads of household $275,000, and single filers earning $250,000. The PEP reduces the total amount of exemptions that can be claimed by 2% for each $2,500 (or portion thereof) by which the taxpayer’s AGI exceeds the $300,000/$275,000/$250,000 threshold. The PEP only applies to taxpayers whose income exceeds the thresholds. For incomes below the thresholds, the PEP does not apply.
Itemized deduction limits apply to high-earners. The limit on itemized deductions, previously suspended, is reinstated for joint filers making $300,000, heads of household making $275,000, and single filers making $250,000. So taxpayers whose income exceeds these thresholds will see total amount of their itemized deductions reduced by 3% of the amount by which the taxpayer’s adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. This limit on itemized deductions does not apply to taxpayers making less than the threshold amounts.
Capital gain and dividend rates rise for higher-income taxpayers. Capital gains tax and dividends tax will be 20% for taxpayers with income over $400,000 (single) and $450,000 (joint filers). This does not include the new 3.8% health care tax on investment income above $200,000 (single) and $250,000 (joint filers) in adjusted gross income, so the top rate for capital gains and dividends will be 23.8 percent. For lower income levels, the tax will be 0 percent, 15 percent, or 18.8 percent.
Gift and estate tax provisions kept with slight rate increase. The bill permanently keeps the exemption level at $5,000,000 (indexed for inflation), and increases the top estate, gift and rate from 35% to 40%. The bill also continues the portability feature allowing a deceased spouse’s estate to transfer his or her unused exclusion to the surviving spouse. All changes are effective for individuals dying and gifts made after 2012.
Permanent AMT relief. The bill provides permanent alternative minimum tax (AMT) relief. The AMT is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%.
The bill permanently sets Alternative Minimum Tax (AMT) exemption at $50,600 (single) and $78,750 (joint filers) for 2012 and adjusts for inflation thereafter.
Payroll tax cut ends. The 2% payroll tax cut ends. Therefore taxpayers should expect greater FICA withholding from their next paycheck.
Additional tax provisions:
The bill contains additional tax provisions that affecting both business and individual taxpayers. Among them are:
- Marriage penalty relief. The bill continues setting the standard deduction for joint filers at 2 times single filers (would have otherwise reverted to 1.67 times single filers).
- Bonus depreciation extension. A one year extension of 50% bonus depreciation rules.
- American Opportunity Tax Credit is extended (education) through 2017.
- Child tax credit. The doubled child tax credit ($1,000) is retained permanently, its refundable portion through 2017, and the expanded earned income tax credit (EITC) through 2017.
- Emergency Unemployment Compensation. The bill extends emergency unemployment compensation (EUC) and extended benefits (EB) unemployment insurance program through January 1, 2014.
- Doc fix. A one year “doc fix” for Medicare payment physicians will continue current Medicare payment rates through 2013, averting a scheduled 26.5% cut in Medicare payments to doctors.
- Roth Conversions. The bill permits 401(k) plan participants to convert their plan to a Roth plan, under which contributions are taxed going in but withdrawals are tax-free. The result is a short-term revenue boost now and more tax-free savings accounts.
There are additional individual and business provisions of the fiscal cliff bill that may apply to you or someone you know. For more information read our full update on: The American taxpayer Relief Act of 2012 by Paul Oliveira, Shareholder, and Director of KLR Tax Services Group.
Please contact any member of our KLR Tax Services Group for assistance with the effect this legislation may have on you or your business.