Well the fiscal cliff, much like the Mayan calendar, and much like Y2K, was just another non-event. A lot of buzz with even a lot more fizzle. The sun has risen, aircraft are safely landing and football dominates the thinking of sports minded folks as we all enjoy the first day of the New Year and the rest of our, hopefully long, lives! Not to downplay the significance of what could have happened had all things remained unsettled and all provisions of previous tax and budget agreements been exercised, just a comment on how often we hear that the World is coming to an end only to find that through all the huffing and puffing nobody’s house was blown down.
Soon we will learn more about the specifics of the 11th hour agreement and we will then hear lengthy discussions from the media and others about how ‘the can just got kicked down the road’! Yes, there are components of the bill that will be ‘permanent*’ but there will still be budget deficit ceiling negotiations, tax reform* discussions and entitlement reform to deal with in the next two months before we can say we have our fiscal house in order, whatever that may look like, remembering that there are differences in opinions about balanced budget management requirements versus budget deficit flexibility, etc., etc. etc.
The Tax Policy Center has estimated, as a result of the Taxpayer Relief Act of 2012, an average annual ‘pocketbook’ hit depending on the following levels of taxpayer income …
$20,000 to $30,000 $297
$30,000 to $40,000 $445
$40,000 to $50,000 $579
$50,000 to $75,000 $822
$75,000 to $100,000 $1,206
$100,000 to $200,000 $1,784
$200,000 to $500,000 $2,711
$500,000 to $1,000,000 $170,341
Taxes on Earnings
Payroll. Everyone will feel the loss of the 2% payroll tax holiday starting January 1, 2013. If you make more than $200,000 (single) or $250,000 (married filing jointly) you will also feel the PPACA (Obamacare) 0.9% additional ‘health care’ tax taken from your paycheck.
Wages and interest income (as well as short term capital gains) will be taxed at the ordinary tax rate brackets which will remain the same as prior years (Bush tax cuts) except for individual taxpayers earning over $400,000 or married taxpayers earning over $450,000. Those taxpayers will see their tax rates go as high as 39.6%. For individuals earning more than $200,000 and married couples earning more than $250,000 there will be a 3.8% ‘health care’ tax added to the taxes paid at ordinary rates for interest income earned (and short term gains but not for wages).
‘Capital Gains and Dividends’
The good news here is that capital gains (long term) and dividends will both still get favorable capital gains tax rate treatment of 0% or 15% if your income is under the $400,000/$450,000 level. If your income is over those amounts, a capital gain maximum rate of 20% will apply. Let’s not forget, however, that the 3.8% ‘health care’ tax ($200,000/$250,000 income levels) comes into play here as well making the potential capital gains rate for those making more than the $400,000/$450,000 a maximum 23.8%.
Alternative Minimum Income Tax (AMT)
This is a break, if you can call anything about AMT a break. For each of the past several years tax preparers have had to wait until the last minute for Congress to come up with a statutory AMT exemption amount (it is like our standard deduction that we have for regular tax purposes) so that we would know who would or would not become subject to AMT. If Congress had not upped the 2012 exemption amount to $78,750 for married couples and $50,600 for individuals, a married taxpayer could have had to pay, perhaps, as much as $8,775 more in taxes in 2012 [$78,750 - $45,000)(.26)].
Itemized Deductions and Personal Exemptions
A couple of years ago there was an income phaseout employed to reduce the benefit a higher income earning taxpayer would get from itemized deductions and personal exemptions. That phaseout for itemized deductions is being brought back for 2013 and will start at $250,000 for individuals, $275,000 for head of household and $300,000 for married filing jointly. Personal exemptions will have the same phaseout dollar filing status threshold amounts, again, for tax years 2013 and thereafter.
Extended through 2013
- Tax free distributions from IRA to charity
- Educator expenses
- State and local sales tax deduction
- Debt relief income recognition exemption for qualified residence indebtedness
- Variety of energy tax credits for energy efficient homes and energy-efficient appliances.
Extended for five years
- Enhanced earned income credit
- American opportunities credit
- Child tax credit of $1,000
- Estates that exceed $5,000,000 will see the estate tax rate increase to 40%
- Annual gift tax exclusion amount is $14,000 per individual for 2013
Again, the good news is that we didn’t end up like Thelma or Louise and we didn’t experience the thrill of a bungee-cliff-dive, both very good things. The bad news is that we seriously need to bring all sides together to address long term fiscal soundness through tax, entitlement and budget reform. All in all this Taxpayer Relief Act of 2012 is very modest in tax law changes and tax savings so a lot of work will need to be done in the next two months. Let us hope that this year’s group of elected officials can get the job done! Happy New Year to All!
David Bergmann, CFP®, EA, CLU, ChFC
The David Bergmann Group
Marina Del Ray, CA