Late at night on New Years day, Congress voted to approve the Fiscal Cliff deal worked out by the Senate late the night before. In a last minute vote, Republicans were able to add enough votes to pass the bill and send it on to the President. The result of the deal is an extension of the Bush tax cuts for most families, a permanent patch to the AMT, and some certainty on Estate Tax. What the deal failed to do is address spending cuts, renew the Social Security tax holiday, or offer enough permanent reform to keep us from the next “fiscal cliff” in February with the debt ceiling.
Here are the details of the bill:
- Income tax rates will stay the same unless you make $400,000 ($450,000 for Married Filing Joint). For these upper income earners, the income tax rate will increase to 39.6%.
- Capital gains and dividend tax rates will jump to 20% for those same upper income earners. Combined with the tax in Obamacare, this means an effective top rate of 23.8% on capital gains and dividends. Don’t forget that a result of the Affordable Care Act is an additional 3.8% tax on net investment income when your modified adjusted gross income reaches $200,000 ($250,000 for Married Filing Joint).
- Personal exemptions phase out (PEP) is back for incomes over $250,000 ($300,000 for Married Filing Joint).
- Itemized deductions limitation (PEASE) is back for incomes over $250,000 ($300,000 for Married Filing Joint).
- The Estate Tax top rate will increase to 40%, but the $5 million exemption ($10 million for family estates) will remain unchanged.
- The Alternative Minimum Tax has been patched and indexed for inflation to prevent the need for future last minute patches.
- Bonus depreciation of 50% is back for another year.
- Section 179 limits and 15 year treatment for qualified leasehold improvements were extended.
- The $1,000 child tax credit, earned income tax credit, and $2,500 American Opportunity tax credit for education are all extended for five years. The child tax credit is extended permanently, however the refundable portion is only extended for five years.
- Tax credits for R&D and renewable energy are back for another year.
- Certain other tax benefits such as deductions for teaching supplies, state and local income tax, qualified mortgage insurance premiums, tax free charitable contributions from IRA accounts, and home debt forgiveness exclusions also were included.
- The adoption credit appears to have been made permanent but non-refundable. We will have more information as it comes available.
Here are a couple key items that did not make it into the bill:
- The 2% payroll tax holiday is gone. The result is that Social Security taxes on wages and self employment income is up 2%.
- Any significant spending or entitlement reform did not make the bill. In fact, extensions for unemployment benefits, Medicare payouts, and a delay in sequestration cuts actually cause this bill to add to the deficit; which will guarantee another round of intense fights in Congress in a couple months when we hit the debt ceiling.
The deal overall will save most families a great deal in tax dollars by averting the tax side of the Fiscal Cliff. However, nearly every working family will see their taxes go up 2%, which means less spending money in 2013. We will continue to pour over the legislation and get more details as they come. For upper income earners, the worst case scenario of tax hikes, the marriage penalty, and phase outs of deductions and exemptions is a reality for 2013 and forward. Perhaps the only saving grace for upper income investors is that the dividend rate will remain below the ordinary income tax rate. This will hopefully help the markets as well.
If you have any questions, please don’t hesitate to contact us.