By now, everyone is pretty sick and tired of hearing about the fiscal cliff. The fiscal cliff has been discussed, dissected, analyzed, blogged about, and counted down. It seems every man, woman, toddler and goldfish knows about the fiscal cliff!
Fortunately, Congress finally got its act together and on New Years Day passed legislation that presumably kept the US from falling “off the cliff.” In other words, if nothing had been done to avoid the fiscal cliff, then on January 1, 2013, taxes would have increased for most Americans, many middle class incentives would have expired and several harsh mandatory budget cuts would have begun to take effect, basically cutting many social services Americans rely on.
Now before we go organize a parade to honor our magnanimous government leaders, let’s get realz. This fiscal cliff debate had been going on for years and was a major theme of this election. Everyone knew when the deadline was and what was at stake. By leaving any negotiations on a deal to the very end and then pushing legislation at the last second, our politicians acted like a bunch of high schoolers who had been cutting class all semester long, only to be pulled aside by the school counselor and warned that failure to pull a C- on the final would result in failing 12th grade and staying back a year. So for the last 2 weeks of school (or in the case of Congress, the last 2 days of the year!) the students pulled all-nighters and tried to prove how earnest and hard-working they were about passing chemistry.
So in my mind, there are no heroes in this deal. Although I do applaud Speaker Boehner and Congressman Paul Ryan for standing up for the Bill during the session AND following up by putting their vote where their mouth is.
But now that we’re here, on the other side of the cliff and no one drowned, there’s a brand-spanking-new piece of legislation to wade through. So let’s do this:
What’s in the Bill:
1. Extends low tax rates for most Americans
The Bill permanently extends the Bush tax cuts for most Americans. In other words, the low tax rates that we’ve all enjoyed since President Bush introduced and Congress passed in 2001, will continue to be in force permanently. Individuals who make less than $400,000 will be taxed at those rates (top ordinary income tax rate of 35%, 15% capital gains and dividend tax).
2. Raises taxes on the wealthy
For individuals who make $400,000 or more and families who make $450,000 or more, their taxes will go up. The Bush tax rates were not extended to these individuals and families and so their top tax rate is 39.6%, capital gains and dividends taxed at 20%. Please also note that beginning in 2013, there is an additional tax imposed on investment income thanks to the health care bill. For families who make $250,000 or more, they will have to pay an additional 3.8% tax on capital gains, ordinary income, dividends, royalties and interest on amounts above the $250,000 threshold. So for some unlucky (but wealthy) few–their ordinary income tax rate could be almost 44% and 23.8% tax on capital gains and dividend income.
3. Limits to deductions and personal exemptions are back
In addition, taxes get even more complicated for higher income Americans–even for those who make less than $400,000–because the legislation brings back 2 tax provisions that were frozen by the 2001 Bush legislation. The personal exemption provision (PEP) reduces or eliminates the benefit of the personal exemption for high income earners, and the Pease provision, which limits and greatly reduces the ability of high earners to make certain deductions. These provisions will apply to individuals who make $250,000 or more and families who earn $300,000 or more a year.
4. Sets estate tax and exemption
The bill also addresses and makes permanent the estate tax rate and estate tax exemption, another set of taxes that were in flux over the past 10-12 years because of their temporary status. The estate tax is the amount of tax that a decedent’s (dead person) estate must pay on the value of the assets of the decedent, minus the estate exemption. The new legislation permanently set the estate tax (as well as the gift and generation skipping transfer taxes) at 40% and thereafter adjusted for inflation. The estate exemption–or the amount of a decedent’s estate exempt from tax– remains at $5 million (for couples it is a cool $10 million). This means that for wealthy families, they can continue to shelter up to $5 million of the estate from tax and then pay a 40% tax on the remainder.
5. Extends middle class incentives
The bill also extends several middle class tax credits and incentives for education and families. It extends for 5 years the American Opportunity Tax Credit, the Child Tax Credit and the Earned Income Credit.
6. Extends the AMT patch
It also makes permanent the AMT patch (which is an alternative tax provisions intended to make sure that the wealthy pay their fair share in taxes but because it was never adjusted for inflation when it was created, it has slowly been creeping into the middle class). The legislation allows for the AMT to be adjusted for inflation going forward.
7. The legislation also extends unemployment benefits for workers who would have otherwise run out of benefits this year.
8. Many pro-business, renewable energy and “green” tax credits are also extended.
9. Payroll tax holiday
The Bill did NOT extend the payroll tax holiday. This was instituted two years ago by the Tax Bill of 2010 and basically gave a tax break to every working American. During normal tax years, every worker must pay 6.2% Social Security tax on income. The 2010 Tax Bill cut this tax by 2%, saving Americans about $10-20 in taxes per paycheck. The recent legislation did not extend this tax holiday so this year every worker is back to paying the full 6.2% of tax on up to $113,000 of their income, or an additional $2274 in taxes annually.
What’s NOT in the Bill:
The Bill did not cover any significant budget cuts, entitlement reform, any meaningful deficit reform or corporate tax reform. Many if not all of these issues will be addressed shortly, however, as Congress gets ready for its next major rumble when the government hits the debt ceiling in March. It’s very likely that the Republicans will demand concessions, spending cuts and changes to entitlement during the coming debt ceiling debate. The tension builds….