John R. McCallum, CPA
As 2012 came to a close and the United States hurtled perilously close to plunging over the dreaded “fiscal cliff,” uncertainty about the nation’s tax policies was at an all-time high. The New Year arrived without any major catastrophes and the nation’s leaders managed to pass legislation to avert that most dreaded cliff. Congress passed, and the president signed into law, the “American Tax Relief Act” in the eleventh hour—actually it was the thirteenth hour, but who’s counting—and all is well with the world, right?
Let’s examine what the “Fiscal Cliff Legislation” really means to you. Barring any action from Congress, income tax rates were set to revert back to pre-2001 levels on January 1, 2013. Prior to changes in the tax rates under the George W. Bush administration, the top income tax rate was 39.6%. Starting in 2001, this rate was lowered to 35%. Rates on all other levels of income were also lowered under the “Bush Tax Cuts”. However, those rates had a “sunset date” when they would revert back to previous conditions. Congress has repeatedly extended those rates annually until now. All of these rates remain unchanged except for the addition of a 39.6% top tax rate that will apply to individuals with taxable income over $400,000 ($450,000 for married filing jointly). These same taxpayers will be subject to a 20% capital gains tax rate, while others will still enjoy the 15% capital gains rates that have been in effect for several years.
If you don’t quite make $400,000, you may think you have gotten off without any tax increase— but the reality is that most everyone is already paying more tax in 2013 than they did in 2012. Another tax cut that was set to expire on December 31, 2012 was the “Payroll Tax Holiday” that was enacted under the Obama administration beginning in 2011. This was a 2% reduction in the employee portion of the payroll tax. Everyone that earns a paycheck or has self-employment income is subject to the payroll tax. The Payroll Tax Holiday was allowed to expire as of the end of 2012, effectively raising everyone’s taxes 2% on earned income.
The New Year also marks the beginning of some tax aspects of the “Patient Protection and Affordable Care Act” (more commonly known as Obamacare). Higher income individuals will start paying 3.8% additional tax on Net Investment Income. This effectively creates a rate for high-income taxpayers of 23.8% for long-term capital gains and 43.4% for short-term capital gains.
There are numerous other changes to the tax code that will change how you determine your taxable income. For example, there is now a limitation on itemized deductions at income thresholds of $300,000 for married couples, $275,000 for heads of household, $250,000 for single taxpayers, and $150,000 for married couples filing separately. This reduces the amount of otherwise allowable deductions by 3% of the amount by which the taxpayer’s adjusted gross income exceeds the applicable threshold. However, the total itemized deductions are not reduced by more than 80% under this provision, and there are certain exclusions. Another related change is the phase out of personal exemptions with those same thresholds. The amount of exemptions claimed is reduced by 2% for each $2,500 by which the taxpayer’s income exceeds the threshold.
Some other changes resulting from the “Fiscal Cliff Legislation” include setting the new maximum estate tax rate at 40%, with an annually-adjusted $5 million exclusion for the estates of those dying after December 31, 2012. Estate tax rates have varied greatly over the last decade and this may help to at least provide some amount of certainty so that families can plan accordingly. The Act also includes a “patch” for the dreaded Alternative Minimum Tax, which will now be adjusted annually for inflation, rather than being dependent on Congressional action on an annual basis. A number of credits were also extended permanently, including the child tax credit, the earned income tax credit, the adoption credit, and the child and dependent care credit, among others.
Some notable changes for business owners include setting the dollar limit for section 179 expensing at $500,000 with a $2 million investment limit. Also, 50% “bonus” depreciation was extended through 2013 and the Research and Development tax credit was also extended for another year. A number of other lesser-known tax provisions were also extended.
These are only the highlights of some very wide-sweeping legislation, and there are many more details that you may want to explore. But it is safe to say that you are going to see some increased payroll taxes if you earn a paycheck—and if you are in the higher income tax brackets, you will see some significantly increased rates. It is increasingly important to consult with a tax advisor to make sure you aren’t paying more than your fair share. Remember to heed the advice of the anonymous quote, “you must pay taxes, but there’s no law that says you gotta leave a tip.”
John R. McCallum is a Principal in the CPA Firm Grantham Poole with offices in Ridgeland and Oxford. See the website at www.granthampoole.com or telephone 601 499-2400.