Fiscal Cliff Tax Increases Set to Affect Almost Everyone Unless Congress Acts

What would taxes look like if no agreement was made?

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As I mentioned in my last post, Congress has the job of negotiating next year’s taxes and spending cuts in a way that will not dramatically throw our economy off the fiscal cliff. So just what would taxes look like if no agreement were made? The current tax code, as written, would change the following parts of the income tax formula:

Bush-era tax cuts expiring

Ordinary income tax rates are scheduled to rise for all taxpayers who have more income than deductions.

10% tax rate changes to15%

15% stays the same

25% tax rates changes to 28%

33% tax rate changes to 36%

35% tax rate changes to 39.6%

The current long-term capital gains rate changes from 15% to 20%. In 2012, taxpayers whose ordinary income tax rate is either 10% or 15%, have a long-term capital gains rate of 0%. In 2013, these taxpayers will pay either their ordinary rate (15% if taxable income is similar) or 20%, whichever is less.

Qualified dividends are scheduled to be taxed at ordinary income tax rates. Since 2003, qualified dividends have been taxed at the long-term capital gains rate of 15%. The IRS defines a qualified dividend as dividends paid to shareholders who have held the stock for at least 60 days before, on, or after the ex-dividend date. The corporation must also be a US-based business.

The Child Tax Credit gives parents of children up to age 16 a $1,000 tax credit per child, subject to income limitations. This credit is scheduled to change to $500 per child in 2013.

Other tax cuts expiring in 2012

Taxpayers itemizing their deductions have had the opportunity in recent years of deducting either their state and local income taxes or sales taxes. This has been particularly beneficial for states with no income tax, low income tax rates, or retirees in states that don’t tax retirement income. This provision is set to expire, so taxpayers will only be able to deduct state and local income taxes.

The deduction for qualified tuition scheduled for 2012 is to be its last year. There are still other college-related tax credits still available for 2013.

Estate tax

The Federal Estate Tax has an exemption of $5 million and a top tax rate of 35% in 2012. In 2013, the tax changes to an exemption of $1 million with a top tax rate of 55%. This drop in exemption amounts from $5 million to $1 million would potentially create an estate tax issue for many individuals. Married couples will still retain “portability” of their exemptions, which would allow a married couple to exclude $2 million from estate taxes.

As currently written, the new provisions in the tax code would affect almost every tax payer. Congress is in the process of negotiating taxes and spending cuts and it looks unlikely that all of these tax increases will stay. Predicting which ones will be changed, and to what extent, is anybody’s guess.

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