The partial passage of the Fiscal Cliff deal, we’ll call this Fiscal Cliff Part 1, was enough to avert falling off the cliff. Part 1 of the Fiscal Cliff focused on the tax law changes but “kicked the can down the road” for the cuts to spending (aka sequester cuts) which will be accompanied by the raising of the U.S. debt ceiling most likely around the end of February or March. The passage of Part 1 provided some temporary relief and helped remove some of the uncertainty of excessively higher taxes which in turn caused a sharp rise in the stock market to open the year. The below bullet points are summary of the tax changes that came from Part 1 of the Fiscal Cliff deal:
– The 39.6% income-tax bracket was reinstituted for taxable income greater than $400,000 for single filers and $450,000 for married couples filing jointly. To the extent long-term capital gain or qualified dividend income exceeds the 39.6% threshold, it will be taxed at 20%. The 15% and zero rates for the lower brackets remain intact.
– Though not part of the fiscal-cliff negotiations, keep in mind that because of the new federal health care law, in 2013 single taxpayers with adjusted gross income (AGI) greater than $200,000 and married taxpayers filing jointly with AGI greater than $250,000 will pay a 3.8% Medicare surtax on net investment income over that threshold. They’ll also pay an additional 0.9% Medicare tax on top of the existing 1.45% for earned income over that threshold. Employers will withhold the extra 0.9% for wages greater than $200,000. If you’re married and file jointly, you can claim a credit for any excess withholding on your tax return, if applicable.
– The old “stealth tax” phase-out of itemized deductions, known as the Pease phase-out (named for the Ohio Congressman who introduced it in the 1990s), and the personal exemption phase-out, known by the acronym PEP, both return for 2013 and beyond. However, the phase-outs start at a higher level than under previous law: for single filers with AGI greater than $250,000 and married filing jointly with AGI greater than $300,000. For every dollar over the threshold, itemized deductions such as mortgage-interest expense, charitable contributions and state and local taxes (but not some other deductions, such as investment interest expense, medical expenses and casualty losses) will be reduced by 3% up to a maximum of 80%. Otherwise, Congress left the deductions for such things as charitable contributions and mortgage-interest expense untouched—at least for now.
– Congress also made the higher Alternative Minimum Tax exemption permanent, retroactive for the 2012 tax year and indexed for inflation thereafter. This was a big deal, because without the exemption, roughly 30 million additional taxpayers would have otherwise faced the AMT.
– A number of other provisions were made permanent, such as the $2,000 annual Coverdell Education Savings Account contribution limit, or at least extended for another year or more, such as the $100,000 IRA direct charitable contribution exemption for those 70½ or older.
– There are the usual inflation-adjusted increases for such things as IRA and 401(k) contributions: for 2013, you can contribute up to $5,500 to your IRA, plus a $1,000 catch-up contribution if you’re 50 or older (even if you turn 50 on the last day of the year), and $17,500 to your 401(k), plus a $5,500 catch-up contribution.
– For gift and estate taxes, the $5 million exemption has been made permanent (adjusted for inflation), with a top rate of 40%. The former exemption was $5.12 million with a top rate of 35%, but without Congressional action it would have reverted to $1 million with a top rate of 55%. Finally, the annual gift exclusion has increased to $14,000 from $13,000.
– We have a bit more longer-term clarity on estate taxes, and how you can plan gifts and your estate to take advantage of the latest tax breaks. Congress made permanent the $5 million exemption, adjusted for inflation in future years, which should translate to a $5.25 million exemption for 2013 ($10.5 million for spouses). “Permanent,” of course, only means there’s no more sunset provision built into current law—Congress can always change its mind down the road.
(Source: Charles Schwab “US Economic Strength, Federal Reserve Policy and 2013 Tax Changes”)