Implications of the Fiscal Cliff Deal
One issue was on everyone’s mind at the end of 2012 – would Congress and the President pass any legislation to avoid the fiscal cliff? As you probably know, a bill was passed and signed in early 2013. People are still trying to dissect the implications – and there are implications for everyone no matter where you fall in the tax brackets – of the entire bill. I will explore a few of items that were in the bill that impact the majority of us.
The fiscal cliff deal made permanent most of the Bush-era tax cuts for the majority of Americans. By making these cuts permanent, taxpayers can accurately calculate their tax liability and for the majority these tax cuts help to offset the payroll tax increase. Let’s take a little closer look at the income tax decisions.
The elimination of the Bush-era tax cuts on the highest income households has garnished the most press. The top tax rate will increase from 35% to 39.6% on incomes over $400,000 for single filers and $450,000 for joint filers.
But Congress did not eliminate the 35% tax bracket. Instead, the deal created a new tax bracket. Taxable incomes roughly between $380,000 and the upper limits will be taxed at the 35% rate. Therefore, there are now 7 different tax rates in the income tax system: 10%, 15%, 25%, 28%, 33% 35%, and 39.6%.
Congress also re-instated the Personal Exemption Phase-out and the phase down of itemized deductions for higher income households. Both provisions begin at $250,000 of adjusted income for single filers and $300,000 for families. These provisions effective raise tax liabilities without raising the tax rate by restricting the exemption and deductions of higher income households. It is unknown as to what impact, if any, this will have on charitable giving by these households.
Finally, the fiscal cliff deal includes a “patch” in the Alternative Minimum Tax (AMT) by adjusting its limits with inflation. In effect, the deal will ensure that the AMT will not apply to most middle-class Americans. The patch will allow these individuals to avoid the larger tax liabilities that the AMT brings. According to the Congressional Budget Office, the AMT patch along with the retaining of the majority of the Bush-era tax cuts will raise real Gross Domestic Product by about 1.25% in fiscal 2013.
For the past two years, employees have enjoyed a 2% payroll tax reduction. This holiday was due to expire at the end of 2012. Congress chose not to renew this holiday and the Social Security portion of the payroll tax will return to the 6.2% of gross wages. For self-employed employees, including clergy, they must return to paying the full 15.3% of net income for FICA tax beginning this year as opposed to the 13.3% they were paying for the past two years.
This increase in the payroll tax will cause an increase in overall tax liability for the majority of workers with some estimates are as high as 77% of Americans will see an increase in tax liability. If you are a self-employed worker making quarterly tax estimates, you may want to review your estimates to make sure the increase in the FICA tax is considered.
Capital Gains Taxes
The Capital Gains Tax, the tax on investment earnings, will increase for high income earners under the fiscal cliff deal. For households with adjusted income of $400,000 for single filers and $450,000 joint filers will see their capital gains tax increase from 15% to 20%. For all other filers, the capital gains tax will remain at 15%.
This raise in the capital gains tax may provide a real opportunity for charities and churches. High income households may seek to gift their stocks and avoid paying the capital gains tax rather than sell the stock, paying the tax, and then gifting what is left. Churches need to be prepared to receive gifts of stock and advertise the option, especially to the higher income individuals in their church.
Congress passed a more lenient estate tax under the fiscal cliff deal than what many were predicting. Under the deal, Congress permanently established the exemption level for 2013 federal estate tax at $5.12 million and indexed it with inflation in future years. This means that estates will only be taxed for values over the $5.12 million threshold. However, Congress did raise the estate tax rate from 35% to 40%, making the tax more severe on any estates over the threshold amount.
While most of us feel that we do not need to worry about this level, family farms and family owned businesses need to be very careful. With land prices continuing to soar (a farm in northern Iowa sold for $17,000 per acre recently) it will not take long to reach the threshold. For example, a 1,000 acre farm with a value of a conservative value of $10,000 per acre would have an estate tax of $1.925 million just for the land alone. Most families would not have $2 million on hand to pay this bill and would more than likely have to sell part or all of the property.
Churches have a real opportunity to help church members that are farmers and small business owners to plan carefully to legally avoid these tax consequences and allow the family farm or business to remain with the family.
Adoption Tax Credit
As an adoptive parent, I watched carefully what Congress would do with the Adoption Tax Credit. This credit was set to expire at the end of 2012, but the Congress has made the credit permanent under the fiscal cliff deal. Parents who adopt a child in 2013, may earn a tax credit for their expenses related to the adoption up to $12,970. If a special needs child is adopted, the parents can claim the entire credit no matter the actual costs. There is a phase out for higher income earners. The credit is indexed with inflation, so it will increase each year.
On the downside related to the Adoption Tax Credit, the credit is no longer refundable. For the last two years, parents were able to receive money back if their tax liability was less than their credit. Under the fiscal cliff deal, the Adoption Tax Credit will no longer be refundable.
Child and Dependent Care Credit
The fiscal cliff deal permanently extended the Child and Dependent Care Tax Credit. This is good news for working parents who must pay childcare expenses. Parents will be able to receive a credit for up to 35% of care-related expenses, capping at $3,000 per dependent or $6,000 per family.
Child Tax Credit
The Child Tax Credit has been extended for another 5 years under the fiscal cliff deal. Once can receive a credit of $1,000 per child. Qualifying children must be under 17 years of age, must be a dependent on your return, and meet certain income stipulations. If your Child Tax Credit is larger than your tax liability, you may be able to claim the Additional Child Tax Credit.
Earned Income Tax Credit
Congress extended the Earned Income Tax Credit for 5 more years as well. This credit will reduce the amount of tax that you owe. The amount of the credit is based on your adjusted gross income and the number of dependents claimed on your return. You do not have to have any dependents to qualify but the amount of earned income decreases significantly without dependents.
According the IRS, one out of 5 taxpayers fail to apply for this credit. In 2012, the average credit was around $2,200 with the highest credit in 2012 being $5,891. Be sure to check to see if you qualify in 2013!
Education Credits and Deductions
Under the fiscal cliff deal, Congress extended the American Opportunity Tax Credit through 2017. This credit was formerly called the Hope Credit. It covers the first $2,000 in education expenses plus 25% of the next $2,000 – or a maximum credit of $2,500. The credit is available to single filers earning less than $80,000 and joint filers earning less than $160,000. 40% of the credit is refundable, meaning that you may receive up to $1,000 refunded to you if have no tax liability.
The deduction for tuition and fees has been extended for 2013 only. Students can deduct up to $4,000 of qualified education expenses from their income. Income limits are the same as above, however, one needs to remember that you cannot claim both the deduction and the American Opportunity Tax Credit for the same expenses in the same year.
There are many other changes in the fiscal cliff deal. Knowing which credits and deductions you qualify can help to minimize the impact of smaller wages due to the elimination of the payroll tax holiday. As always, you should check with your tax advisor for all qualifications and implications to your particular situation.
Curtis S. Dubay; “Fiscal Cliff Deal: Tax Increase Spoils Permanent Victory for Most Taxpayers”; The Heritage Foundation; January 9, 2013.
Robert Farley; “Fudging on the Fiscal Cliff Deal”; FactCheck.org; January 4, 2013.
Eugene Kiely and Robert Farley; “McConnell Fudges Fiscal Facts, Too”; FactCheck.org; January 8, 2013.
Tami Lubby; “Fiscal Cliff Deal Raises Taxes on 77% of Americans”; CNNMoney.com; January 3, 2013.
Jean Murray; “Changing Employee Withholding for Increased Payroll Taxes”; About.com Guide;
Jessica Yellin, Danna Bash, and Jeanne Sahadi; “Fiscal Cliff Deal Stops Many Tax Hikes, But Leaves Big Issues Pending”; CNN Money, January 2, 2013.