The “Fiscal Cliff” Solution & How It Impacts You

For the last six to eight weeks of 2012, the media bombarded us with news of the “Fiscal Cliff”, essentially the expiration of the Bush tax cuts passed in 2003. If the tax cuts were allowed to expire, higher tax rates for all would take effect and possibly derail the country’s economic recovery. If the Bush tax cuts were continued, President Obama would not meet his goal of raising revenue by raising taxes on the wealthiest. The compromise was the American Taxpayer Relief Act of 2012, passed by Congress on January 1st and signed by the President on January 2nd.

The act makes the changes permanent, no expiration date. It maintains lower tax rates for most while raising tax rates for high income individuals. The act did little to address spending and the debt.

The main features of the law follow.

• The reduction of payroll taxes for social security was not extended. The deduction for social security in 2013 will be 6.2 percent rather than the 4.2 percent deducted in 2011 and 2012. This change impacted salaried employees lowering take home pay as of January 1st. For 2013, the tax is payable on income up to $113,700.
• For individuals making less than $400,000 per year ($450,000 for married filing jointly) the tax rates for income, dividends, and capital gains remained at the 2012 or Bush tax cut level.
• For those reporting income above these levels:
• The top marginal tax rate on income increased from 35% to 39.6%.
• The top marginal tax rate on capital gains increased from 15% to 20%.
• The dividend tax rate was set to the capital gains tax rate increasing from 15% to 20%.
• The phase-out of tax deductions and credits for individuals with income above $250,000 ($300,000 married filing jointly) was reinstated.
• The Alternative Minimum Tax (AMT) was permanently tied to inflation. The AMT was introduced to ensure that taxpayers with an adjusted gross income above a specified threshold paid some federal tax (a variety of deductions are disallowed). The threshold was not automatically adjusted. Over time more middle class taxpayers were required to pay the AMT. Congress had to pass legislation to adjust the threshold. The threshold is now tied to inflation.
• Estate taxes were raised to 40% of the value above $5 million, adjusted each year by inflation. Estate taxes were 35% of the value above $5,120,000.
• Many Bush era tax credits were extended through 2013 or made permanent. Some were reinstated for 2012. The credits affected include, but are not limited to, the child tax credit, the enhanced Earned Income Credit, tuition credit, child and dependent care credit, and home energy credit.
• Two provisions impact retirement savings.
• Tax free distributions from an IRA to a qualified charity by individuals above 70 ½ years of age have been extended for 2 years.
• Restrictions on 401K participants to transfer funds to an in-plan Roth have been lifted.
• Many temporary business tax provisions were extended. Of primary importance are Code Sec 179 small business expensing, bonus depreciation, the research tax credit, and the Work Opportunity Tax Credit.

Generally, the Tax Relief Act could be summarized by stating “if you have a lot of income, you’ll pay more. If you don’t, your taxes will be about the same”. However, since there are enough different items addressed, particularly on tax credits, you would be wise to consult with your tax preparer.

IRS Circular 230 Disclosure
Pursuant to U.S. Treasury Department Regulations, we are now required to advise you that any federal tax advice contained in this communication, including attachments and enclosures, is not intended by the Sender or Sandra G Johnson, CPA, P.C. to constitute a covered opinion pursuant to regulation section 10.35 or to be used for the purpose of (i) avoiding tax-related penalties under Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.