Everything You Need to Know About the Presidential Re-Election and the Fiscal Cliff
- An increase in tax rates for higher income taxpayers – rates as high as 43.4% for some taxpayers!
- A Medicare Contribution Tax for higher income taxpayers
- The AMT now will effect many more taxpayers
- Increased payroll taxes for all employees
- An increase in taxes on capital gains and dividends
- Dramatic increase in estate taxes (we have covered this in a previous newsletter).
- Drastic reductions in business write-offs for purchases of computer, equipment, vehicles and other assets
- A whole bunch of deductions disappear or are substantially reduced.
Here are the specifics on a lot of the significant items of the “Fiscal Cliff”:
High Income Taxpayers
Year-end tax strategies will demand more urgent attention from higher-income taxpayers as the result of President Obama’s re-election. The President has consistently called for higher tax rates on individuals with incomes above $200,000 and families with incomes above $250,000 and continuation of the current lower tax rates for others. He campaigned on reinstatement of the 36 percent and 39.6 percent income tax rates for higher-income individuals. The President also advocated a maximum capital gains rate increase from 15 percent to 20 percent and a dividend rate rise from 15 percent to 36 percent or 39.6 percent for higher-income taxpayers. His re-election also ensures that the 3.8 percent Medicare contribution surtax on net investment income will go into effect on January 1, 2013, and continue into the foreseeable future.
Under President Obama’s proposal, the 36 and 39.6-percent rates would start at a higher-income bracket level of $200,000 for single filers, $250,000 for joint filers, $225,000 for head-of-households, and $125,000 for married taxpayers filing separately. Since these thresholds were initially proposed in 2009, they would also be indexed for inflation. Also they would be keyed to adjusted gross income (AGI) rather than taxable income. Indexed 2013 projections for those AGI levels, based on the Administration’s fiscal year 2013 Budget, are $213,200 / $266,500 / $239,850 / and $133,250, respectively.
While it is not absolutely certain that tax rates will rise in 2013, it is more than certain that rates will never drop lower than they are now in 2012 for most higher-income taxpayers.
Higher-income taxpayers must decide whether to wait-and-see or secure the benefit of current rates now, through accelerating income, postponing deductions/credits, harvesting appreciation/capital gains, having closely-held corporations declare special dividends, closing business sales/acquisitions, and executing family gift-giving strategies—all before year end 2012.
Medicare Contribution Tax
The Affordable Care Act imposes a 3.8 percent Medicare contribution tax on the unearned income of higher-income individuals, estates and trusts effective January 1, 2013 including, but not limited to dividends, interest, and capital gains. The Medicare contribution tax applies to net investment income (NII), and will generally apply to passive income. The Medicare contribution tax also applies to capital gains from the disposition of property. For individuals, the Medicare contribution tax will apply to the lesser of the taxpayer’s NII or the amount of “modified” adjusted gross income (AGI with foreign income added back) above a specified threshold.
The Medicare contribution tax is not applicable to income derived from a trade or business, or from the sale of property used in a trade or business.
NII for purposes of the Medicare contribution tax includes gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business; gross income from a trade or business that is a passive activity; gross income from a trade or business of trading in financial instruments or commodities; and net gain (taken into account in computing taxable income) from the disposition of property that is not held in an active trade or business.
Additional Medicare Tax
The Affordable Care Act also imposes an additional 0.9 percent Medicare tax on higher-income individuals, effective January 1, 2013. The additional Medicare tax applies to total wages, other compensation, and self-employment income that exceeds the applicable threshold amount for the individual’s filing status.
When the limitation of itemized deductions and the medicare surtax is considered, high income taxpayers could be paying an effective rate of 43.4%!
Alternative Minimum Tax (“AMT”)
The single largest impact on taxpayers is the AMT. The Congressional Budget Office estimates that over 20 million additional middle-income taxpayers will become subject to the AMT without the so-called “AMT patch” for 2012. Without this patch, the amounts exempted from the AMT calculation fall singificanly meaning that more income is taxed at AMT rates.
Increased Payroll Taxes
Another likely possibility is an extension of some sort because without it, wage withholding at the higher tax rates would become mandatory for all taxpayers at all income levels. This is compounded by the expiration of the expiration of the payroll tax deduction for employees which will take another 2% out of their pay checks.
Increase in taxes on capital gains and dividends
Under the President’s proposal, the current zero and 15 percent capital gains and dividend tax rates would be extended after 2012 for single individuals with incomes below $200,000 and families with incomes below $250,000.
The President’s proposal would increase the tax rate on qualified capital gains to 20 percent for single individuals with incomes over $200,000 and married taxpayers filing a joint return with incomes over $250,000. Regarding dividends, single individuals with incomes over $200,000 and families with incomes over $250,000 would pay tax on their dividends as ordinary income.
Drastic reductions in business write-offs for purchases of computer, equipment, vehicles and other assets
Small Business Expensing
Enhanced Code Sec. 179 expensing is scheduled to expire after 2012. Unless extended, the current expensing amount of $139,000 (as indexed for inflation) is scheduled to fall to $25,000 and the current $560,000 investment limit (as indexed for inflation) is scheduled to fall to $125,000.
Bonus depreciation at its current 50 percent rate is scheduled to expire after 2012 (after 2013 for certain transportation property and longer-lived property). It is unclear if President Obama will support an extension of 50 percent bonus depreciation.
Other Major Expiring or Reduced Provisions
- Higher education tax deduction
- State and local sales tax deduction
- Teacher’s classroom expense deduction
- American Opportunity Tax Credit
- Coverell Education Savings Accounts
- Student loan interest deduction
- Medical deductions must now exceed 10% of adjusted gross income (up form 7.5%).