Fiscal Cliff Averted? It All Depends.

Search the term “fiscal cliff averted” and you’ll get about 57 million hits in a quarter of a second.  Is that proof enough that we did, in fact, avoid a cataclysmic spill over a scary economic precipice?  As a nation, perhaps so.  But if you now find yourself approaching the highest income tax bracket, you may not feel as if you averted anything at all!

The newly enacted American Taxpayer Relief Act of 2012 preserved lower tax rates and other benefits for nearly all households.  But as household income increases, taxpayers may now be climbing a personal tax mountain that feels as daunting as the fiscal cliff the nation just dodged.  Here’s what you need to know. 

Payroll Tax Holiday Sunset

The consequence of the new tax law that affects the most people is actually not in the law at all.  For the past two years employees and self-employed workers have enjoyed the benefit of a two percent reduction in the Social Security tax rate.

The result was an average boost of about $2,200 for the typical taxpayer.  Because this reduction was not renewed for 2013, the Social Security rate returns to 6.2%, and, as a consequence, take home pay will go down.

$250,000 Income Threshold

Additional wage and investment surtaxes enacted with the 2010 healthcare reform legislation took effect at the beginning of this year.  This means that every dollar in wages over $250,000 is now subject to a Medicare tax of 0.9%.   

Once total income surpasses the $250,000 threshold any investment income – dividends, interest, rents, most capital gains and other types of unearned income – is now subject to a 3.8% Medicare tax.

These taxes are assessed on top of the taxes that ordinarily apply to wage and investment income.

$300,000 Income Threshold

At the $300,000 income level, you begin to give back certain tax benefits available to taxpayers at lower levels.  For example, itemized deductions such as charitable contributions, real estate taxes and mortgage interest can be reduced up to 80% of the otherwise deductible amount.

Additionally, the value of personal exemptions for you, your spouse and your children will gradually be phased out.

$450,000 Income Threshold

If your income exceeds $450,000, you will likely be subject to the new higher tax rates governing ordinary and capital gains income.  The top rate applying to ordinary income is now 39.6% (up from 35% last year), and the new capital gains rate is 20%.  A capital gains rate of 15% still applies if income is below $450,000.

Business Provisions

Since most businesses are organized as passthrough entities, (business income passes through the entity and is reported by its owners), the new individual tax provisions will have a major impact on business planning.

One encouraging development is the extension and expansion of tax rules that make it easier for businesses and owners to write off capital equipment purchases.  Retroactive to the beginning of 2012, businesses can deduct up to $500,000 in qualifying purchases during the year.

With top income tax rates approaching 40%, this provision represents a significant inducement for businesses to make infrastructure investments. The half-million dollar annual threshold remains in effect through the end of this year.

Is It A Cliff?  Is It A Mountain?

It’s impossible that any financial policy decision – let alone one with the potential impact of that scary fiscal cliff – results in consequences that are “all good” or “all bad.”   No matter how neatly the politicians try to wrap the package, there are always surprises, some welcome and others less so, that straggle out.

My advice for taxpayers is to do your own investigation, or enlist a trusted tax advisor, into what these changes will mean for you. Only then will you know if you’re falling over a cliff, climbing a mountain or resting easy…at least until the next crisis erupts. 

About dentbaker

Accounting Service Firm
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