Fiscal Cliff Deal Tax Changes

On Jan. 1, the House and Senate reached agreement on a deal to avoid the full force of $600 billion in tax hikes and spending cuts that many economists believed would return the U.S. economy to a recession. Although the legislation does not address many of the larger budget issues, it does rescind what would have been dramatic tax increases for the majority of Americans.

The American Taxpayer Relief Act prevented the expiration of the tax cuts passed in 2001 and 2003 for the vast majority of Americans and maintained the preferential tax status of qualified dividends and municipal bond income. Let’s look at the details:

Payroll Tax: Most Americans will see reduced paychecks because the employee Social Security payroll tax rate is restored to 6.2 percent on income up to $113,700. The rate had been temporarily reduced to 4.2 percent for 2011 and 2012 as an economic stimulus measure.

Income Tax Rates: The 2001 and 2003 tax rate cuts are permanently extended for single filers with incomes below $400,000 and joint filers with incomes below $450,000. For taxpayers with income above these thresholds, the tax rates increase from 35 percent to 39.6 percent.

Capital Gains and Dividends: The 0 percent and 15 percent tax rates for long-term capital gains and qualified dividends are permanently extended for taxpayers with incomes below the $400,000 single/$450,000 joint filer thresholds. The top rate increases to 20 percent for filers with income above those amounts.

Alternative Minimum Tax Patch: The legislation permanently extends the AMT Patch with annual inflation adjustments. The troublesome AMT Patch had become a subject of annual year-end wrangling in Congress because without an emergency patch, more and more people would be subject to the AMT. The annual adjustments are designed to finally eliminate that problem in the future.

Limitations on Exemptions and Deductions for High-Wage Earners: The legislation reinstates the phase-out of personal exemptions and the limitation on itemized deductions for single filers with adjusted gross incomes above $250,000 and joint filers with AGI above $300,000.

3.8 percent Medicare Tax for High Earners: Enacted as part of the Affordable Care Act, the 3.8 percent Medicare tax applies to the investment income of single filers with modified adjusted gross incomes above $200,000 and joint filers above $250,000. Although technically not part of the year-end tax deal, many members of Congress wanted the provision repealed as part of the fiscal cliff negotiations.

Estate and Gift Tax: The legislation increases the top rate for estate and gift taxes from 35 percent to 40 percent while permanently extending the lifetime estate and gift tax exemption to $5.12 million, with annual inflation adjustments. In addition, unification of the estate and gift tax and spousal portability is permanently extended.

Other Provisions: The deal also extends unemployment benefits and provides a two-year extension to several annually expiring provisions such as the allowance of tax-free rollovers of an IRA to qualified charities. In addition, certain tax credits that were enacted in the 2009 stimulus bill are extended for up to five years, including the American Opportunity Credit and the refundable aspects of the Earned Income Tax Credit. Finally, participants in employee retirement plans can make conversions to Roth plans (and pay the applicable tax) if their employer offers such a plan.

Although Congress simply delayed making decisions on many of the pressing spending issues involved with the fiscal cliff, Washington did at least provide some certainty on the tax issues Americans will face in 2013. Although taxes will go up for many, they will not rise nearly as much as they would have if there had been no agreement. The new law magnifies the importance of having a tax-sensitive strategy for income, investments and retirement. Professional tax advisors are always available to help you achieve your long-term goals.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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