What the Fiscal Cliff Means for Taxes
(As the country approaches the dreaded Fiscal Cliff, the Taxpayers Protection Alliance [TPA] will continue to talk about the importance of spending cuts and highlight program that are prime to be cut. In addition, every Thursday TPA will be discussing the taxation side of the Fiscal Cliff with the Taxation Thursday blog posting) As most Americans begin to prepare for the holiday, they might also want to include a conversation with their accountant as part of their holiday plans to try and assess what their tax liability is for the coming year. If no action is taken by Congress by the end of the year taxes will go up by about $400 billion for millions of Americans. Increases include exemptions of things like employment taxes, childcare and investments, activities that are likely to be affected by increased costs. According to taxsquad.com, here is a breakdown of what the increases will look like after December 31, 2012:
- Exemption Phase-Out - Each taxpayer is entitled to a $3,800 (2012) tax exemption (deduction) for him or herself, his or her spouse, and each dependent. Beginning in 2013, a phase-out (reduction) of the exemptions will return for higher income taxpayers. The otherwise allowable exemption amounts will be reduced by 2% for each $2,500 or part of $2,500 ($1,250 for married filing separately) that the taxpayer's AGI exceeds the AGI threshold for the year based on the taxpayer's filing status.
- Itemized Deduction Phase-Out - Beginning in 2013, higher income taxpayers will again be subject to the phase-out of itemized deductions. Not all itemized deductions are subject to phase-out. The following are the ones subject to phase-out: taxes, interest (except investment interest), charitable contributions, employee job expenses and other miscellaneous itemized deductions (excluding gambling and casualty or theft losses).
- Payroll Tax & Self-Employment Tax - Both the payroll withholding tax and self-employment tax rates have been reduced by 2 percentage points for two years. Payroll FICA withholding will return to 6.2% (up from 4.2%) and self-employment tax will return to 12.4% (up from 10.4%) beginning in 2013. Impact: All working taxpayers.
- Long-Term Capital Gains Rates Increase – Taxpayers have enjoyed reduced long-term capital gains rates for several years as a result of the Bush-era tax cuts. However, those reduced rates will return to the higher rates in effect prior to 2003. The table below compares the current long-term capital gains rates to the anticipated rates for 2013 and subsequent years. Taxpayers with unrealized gains in investment property they’ve held for over one year may want to consider selling some or all of those assets in 2012 to lock in the lower long-term capital gains rate on their gains. Impact: All taxpayers with long-term capital gains.
- Regular Tax Rates – In addition to lower long-term capital gains rates, the regular marginal tax rates have been declining since 2001. However, without Congressional action, those reduced rates will return to the higher rates that were in effect prior to 2001. The table below compares the current marginal individual tax rates to the anticipated rates for 2013 and subsequent years. These increased rates will apply to all varieties of ordinary income, including interest, dividends, short-term capital gains, employment income, etc. Marginal tax rates increase as a taxpayer’s overall income increases, taxing the first block of income received at the lowest rate and each subsequent block at ever-increasing rates until the maximum rate is reached. As with assets eligible for the long-term capital gains rates, it may be appropriate for some taxpayers to accelerate ordinary income into 2012 to take advantage of the lower rates. Impact: All taxpayers.
- Bonus Depreciation Expires – For several years, businesses have been able to take advantage of bonus depreciation that essentially allows a 50% (100% during some periods) depreciation deduction of the cost of qualified business equipment and machinery in the first year it is placed in service. The big business write-off expires after 2012. Impact: Larger businesses.
- Coverdell Education Accounts – Some years back, the tax benefits related to Coverdell Education Accounts were liberalized and made more beneficial to taxpayers. Those liberalized benefits will no longer apply after 2012. The most notable of these changes are: the dollar limit on contributions for any one beneficiary is reduced to $500 from $2,000, contributions can be made only by individuals, the modified AGI phase-out range for the annual contribution limit will be $150,000 - $160,000 for joint filers instead of twice the amounts for single filers ($95,000 - $110,000), contributions for special needs students age 18 or over will no longer be allowed, contributions for the tax year must be made by December 31 (was April 15 in the following year), qualifying expenses will no longer include those related to elementary or secondary school expenses, contributions to a Coverdell account and a Sec 529 Qualified Tuition Program will no longer be allowed in the same year, and education credits cannot be taken in a year in which a Coverdell withdrawal is made. Impact: Lower to moderate income families.
- American Opportunity Tax Credit Expires – The American Opportunity Tax Credit (AOTC), which took the place of the Hope Education credit beginning in 2009, will expire after 2012. This liberalized credit provided a credit of up to $2,500 (the Hope credit provided only $1,800), and where the Hope credit could be used only to offset a taxpayer’s tax liability, up to 40% of the AOTC is refundable in many instances. In addition, the ATOC provided 4 years of credit, while the Hope credit only applies for two years. The AOTC expires after 2012. Impact: Lower income families.
- Higher Education Loan Interest – A deduction of up to $2,500 is allowed for interest paid on loans for higher education. This deduction was originally limited to the first 60 months for which the interest payments were required. Congress subsequently temporarily eliminated the 60-month limitation and increased the AGI phase-out. Beginning in 2013, the 60-month rule returns and the AGI phase-out ranges (before adjustment for inflation) will be reduced to $60,000 - $75,000 for joint filers and $40,000 - $55,000 for other filers (except married couples filing separately who are barred from claiming this deduction). Impact: Lower to moderate income taxpayers.
- Alternative Minimum Tax (AMT) – Congress originally implemented the AMT to impose a minimum tax on higher-income taxpayers who were avoiding taxes through tax shelters and other legal means. However, years of inflation without corresponding adjustment to the AMT components have, each successive year, caused an increasing number of taxpayers to be subject to the AMT. Much as the regular income tax allows personal exemptions, the AMT calculation allows an exemption, but based upon filing status. For the past several years, Congress has, on a year-to-year basis, increased that exemption for inflation. However, should they fail to provide an increase for 2012 and 2013, the exemption amounts would revert to levels not seen since the early 2000s, which, depending upon filing status, would result in an approximate 30% to 40% decrease in the exemption amount. For example, the exemption amount for joint filers would drop from 2011’s $74,450 to $45,000. The reduction of the exemption amount would snare a significantly greater number of taxpayers for 2012 – estimated to be around 31 million versus 4 million for 2011. Impact: Generally, middle income taxpayers.
- Child Tax Credit – Since 2003, the child tax credit has been $1,000 for each qualified child of a taxpayer who is under the age of 17 at the end of the year. However, this was a temporary provision that expires at the end of 2012, and, beginning in 2013, the credit will revert to $500 per child. In addition, the refundable portion of the credit will be reduced. Impact: Lower income taxpayers with children.
- Child & Dependent Care Credit - As part of the Bush-era tax cuts, the maximum expenses qualifying for dependent care credit were raised from $2,400 ($4,800 for two or more qualifiers) to $3,000 ($6,000 for two or more qualifiers) and the income-based maximum credit percentage was raised from 30% to 35%. However, these increases are scheduled to revert to the lower amounts in 2013. Impact: Lower income working taxpayers with children.
- Earned Income Tax Credit – In 2009, a credit category for three or more children was added, providing an increased credit for taxpayers with three or more qualifying children. However, that was a temporary measure which will expire at the end of 2012. This will reduce the maximum credit for individuals with three or more children by $650 in 2013. Other changes that enhanced and simplified the credit computation are also set to expire. Impact: Lower income taxpayers with large families.
These increases amount to much higher taxes for nearly all Americans. Many policy makers will make the argument that these increases are just the sun-setting of temporary tax benefits, but as most taxpayers know, allowing taxpayers to keep more of their money is the best way to grow the economy. Giving more money to the government just means that the government has more to waste.