One Fiscal Cliff-hanger is Over

They call it the American Taxpayer Relief Act. Funny, that. Overall it produces tax increases – that’s relief?

Early January 1, 2013, the Senate, by a vote of 89-8, passed the “American Taxpayer Relief Act”. Late on that same day- after the government had technically gone over the “fiscal cliff” – the House of Representatives, by a vote of 257 to 167, also passed the bill. The Act, which we expect the President to gain imminently prevents many tax increases from going into effect, but it increases income taxes for some high-income individuals and slightly increases estate and gift taxes.

Other fiscal cliffs remain in our future. The debt ceiling cliff is coming in a month or two and the sequester cliff comes in March (since the Act put off the automatic sequester cuts for two months).

Here are the highlights from the new Act:

Estate and Gift Taxes.

The estate tax exemption slated to fall to $1 million has been retained at the 2013 level of about $5.27 million. The top rate was slated to go from 35% to 55%. The Act provides an increase in the top rate to 40%.

For those taxpayers who made large gifts in 2012 to use your exemption before it fell to $1 million, for most of you this was still good planning. Future income and growth on those assets has been removed from your future taxable estates. Plus, who knows how long this law will be with us? There is no “sunset” with this law, but Congress can always create an instant “sunset”.

The Act also includes the extension of “portability” which allows the estate of the first spouse to die to transfer his or her unused estate tax exemption to the surviving spouse.

Dividends and Capital Gains.

The maximum rate on dividends and capital gains will be 23.8%, up from 15 % in 2012. The 23.8% rate includes the new 20% maximum capital gains tax plus the 3.8% surtax from the Affordable Care Act. (The surtax applies only to individuals with over $200,000, and married couples filing jointly with over $250,000, in modified adjusted gross income.)

Individual Tax Rates

. Individual rates have been retained at 10%, 15%, 25%, 28%, 33% and 35% . A new 39.6% rate applies to income of $450,000 for joint filers, $425,000 for heads of household, and $400,000 for single filers. There is a marriage penalty here. Two single people living together could each make up to $400,000 before the 39.6% rate applies. A married couple filing jointly pays the 39.6% when combined income exceeds $450,000.

Alternative Minimum Tax

. The Act has made permanent an increase in exemption amounts, and the index of those amounts with inflation. No more year-end panic waiting for an AMT patch. Before the Act, the individual AMT exemption amounts for 2012 were to have been $33,750 for unmarried taxpayers, $45,000 for joint filers and $22,500 for married persons filing separately. Retroactively effective for tax years beginning after 2011, the Act permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. Beginning in 2013, these exemption amounts are indexed for inflation.

Personal Exemption Phaseout.

Personal exemptions begin to phase out for those making $300,000 for joint filers, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately.

Itemized Deduction Phaseout

. Itemized deductions are reduced by 3% of the amount by which the taxpayer’s adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The starting thresholds are $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately.

The effect of these phase-outs is to raise the top bracket from 35% to 41%.

Charitable Contributions from IRAs.

The ability to make tax-free distributions from individual retirement plans directly to qualifying charities has been extended through 2013 and made retroactive for 2012.

Payroll Tax Cut Allowed to Expire.

An extension of the 2% payroll tax cut that expires at the end of 2012 was not included in the Act. These taxes go back up to 12.4% from last year’s 10.4%.

5-year Extensions.

The following credits slated to expire at the end of 2012 have been extended for 5 years: Child Tax Credit, Earned Income Tax Credit, and the American Opportunity Tax Credit.