When I advised my clients to complete their transactions in 2012, it was apparent that the effects of the actions our elected officials were going to take to avoid the “fiscal cliff” could only have a negative effect on taxes. At the twelfth hour, Mitch McConnell, Republican Senate Minority Leader bypassed Nevada’s own Harry Reid and reached out to Vice President Joe Biden with whom he had worked with when Biden was in the Senate. They worked out a compromise that was passed in the Senate and the House on January 1.
How does this affect you?
The tax rate for taxpayers with income over $450,000 married and $400,000 single increased from 35% to 39.6%. The tax rate on capital gains and dividends increase from 15% to 20% also applies to this threshold. When combined with the 3.8% healthcare tax, that tax rate on capital gains and dividends becomes 23.8%.
Some of you may be breathing a sigh of relief that the tax rate increase will apply only to those taxpayers. However, the 3.8% healthcare tax on investment income will hit those of you with taxable over $250,000 married and $200,000 single (see my blog in November 2012 regarding the healthcare tax of 3.8%). Also, itemized deductions are phased out at $300,000 for joint filers and $250,000 for singles, effectively raising their taxes.
Interestingly, the bill does not say whether the $400K/$450,000 threshold refers to adjusted gross income (AGI) or taxable income. AGI doesn’t include subtractions for itemized deductions, while taxable income does. With so many phase-outs of itemized deductions for taxpayers in the higher brackets, this may not be of much consequence to most of these affected taxpayers.
The payroll tax holiday reducing payroll taxes and self-employment taxes by 2% is over. The tax rate increases from 4.2% to 6.2%. That means for an individual earning the maximum 2013 cap of $113,700 or more, the increase would be $2,274, or nearly $200 per month.
The alternative minimum tax (AMT) still effectively eliminates many tax breaks for the higher income tax brackets. AMT was created in 1969 to ensure that wealthy taxpayers pay at least some minimum amount of federal income tax, regardless of deductions, credits or exemptions. In essence, it is a flat tax with two brackets, 26 percent and 28 percent. Under the new deal, Congress has finally created a permanent inflation “patch” that would allow millions to escape AMT. Without the patch, the AMT would have hit 31 million taxpayers this year, reaching deeply into the middle class.
What the bill did not include:
The bill only addressed the revenue side of the budget question and deferred action on the spending side for two months. Additionally, the agreement does not address any increase in the nation’s debt ceiling.
A strong economy depends upon predictable behavior and decision-making by the government. The competitive environment is unpredictable enough without our government making it more unpredictable. This has been lost on our elected officials much to the consternation of almost everyone: businessmen, employees, bankers, homeowners, and investors. Get ready for the budget and spending standoff two months from now.