Debunking the Fiscal Cliff Deal (and How It Impacts You)
– Special Report January 2013
Happy New Year! While the bulk of us were bidding adieu to 2012 and toasting in 2013, our elected officials in Washington, D.C., were working on a deal to avert the fiscal cliff! Of course, they had months to do so, but waited till the last possible moment.
The good news is that the tax policy is now very clear. In fact, it is clearer than it’s been in years. The bad news is that some higher-income folks will pay more than what they’re accustomed to. Additionally, all wage earners will see a change in their first 2013 paycheck and new taxes resulting from the Health Care Act of 2010 will go into effect this year.
We’re still sorting through the regulations and changes. However, here are a few that may have an immediate impact on you as well as information on some retirement plan contribution modifications:
Immediate impact
As of Jan. 1, 2013, the payroll tax holiday expired. In 2011 and 2012, Congress cut the employee portion of Social Security from 6.2% to 4.2% for every wage earner in the U.S. However, this holiday is gone, so everyone now is paying the pre-2011 rate of 6.2%. Your first 2013 paycheck will reflect this.
The amount you can put away in retirement accounts has changed as of Jan. 1, 2013, as well. The IRA contribution limit increased from $5,000 to $5,500. In addition, the 401(k)/Roth 401(k) limit changed from $17,000 to $17,500, and Simple IRA contribution limits increased from $11,500 to $12,000. If you’re 50 years of age or older, you can make an additional contribution to your IRA of $1,000, and $5,500 to 401(k) plans/work retirement plans, which are the same in 2013 as they were in 2012.
“Fiscal Cliff” tax summary (major provisions)
- Tax rates – Most tax rates remained the same, except for the addition of a 39.6% rate on income above $450,000 for married couples, and $400,000 for single filers. The 2012 rate was 35%, so this is a 4.6% increase. That doesn’t mean everyone who earned $450,000 and above will be taxed at that rate; just the income above it. So, for example, if you’re married and have taxable income of $500,000, $50,000 of your income will be taxed at 39.6% (instead of 35%), which is an increase of $2,300.
- Alternative minimum tax – Congress permanently addressed this issue. Now, instead of them making yearly change, this tax will be linked to inflation and change each year automatically.
- Estate tax – The exclusion remains at $5,000,000 each. However, the rate above the exclusion will be 40% (changed from 35% in 2012). The exclusion also is portable, meaning that upon the death of one spouse, the other spouse gets both exclusions (or $10,000,000). For example, if you’re married and your estate is worth $11,000,000, $10,000,000 will be tax free and you’ll pay taxes on $1,000,000 at 40%. As a result of this change, most people in the U.S. will no longer have to worry about estate taxes. In addition, it’s a permanent change; not a temporary one like we’ve had for some time.
- Capital gains and dividends – The rates remain the same for everyone except those who fall into the higher bracket. For the highest bracket, the rate is 20% (instead of 15%).
- Itemized deductions (e.g., home mortgage, property taxes, etc.) – These will be phased out for incomes over $300,000 for married couples, and $250,000 for single filers. The phase-out isn’t new; it was there until 2010. It’s simply back in effect.
- Business tax provision – This provision for allowing 50%bonus depreciation will continue in 2013. Part of this is the “SUV deduction,” which will mostly continue in 2013.
Health Care Law Taxes (a.k.a. ObamaCare taxes)
- Medicare surtax – Employees making more than $250,000 ($200,000 for single filers) will pay an additional 0.9% taxes on their wages.
- Net investment income tax (NIIT) – This is 3.8% tax on investment income above certain thresholds. The tax is triggered on the lower of NIIT or the amount in excess of the threshold ($250,000 for married couples, $200,000for single filers). For example, if a married couple made $270,000 last year and their investment income was $30,000, the lower of NIIT or threshold would be $20,000 ($270,000 – $250,000). The tax of 3.8% would apply to the $20,000, not the actual $30,000 income. Income such as bank/bond interest, dividends and capital gains are the major ways in which NIIT is triggered.
- Flexible spending contributions – This will cap at $2,500.
- Medical care itemized deduction threshold – The new limit is 10% (it was 7.5%). In the past, if your adjusted gross income had been $100,000 and your unreimbursed expenses were $10,000, then $7,500 (7.5% x $100,000) wouldn’t have been allowed and you only would have been able to deduct $2,500. Using the same income and expenses, but with the new threshold of 10%, $10,000 would be disallowed, so there would be no deduction.
We’ll share more changes in the tax code for 2013 and beyond as they become evident. Always consult your CPA for advice specific to your tax situation. Your Redwood Wealth Management advisors are here to answer your questions.
Raj Chokshi CPA, MBA, CFP®
Partner, Senior Wealth Manager
