What the Fiscal Cliff Fix Means to You

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What the Fiscal Cliff Fix Means to You Congress came through in time to avoid the largest tax increase in history when they passed the American Taxpayer Relief Act of 2012 (ATRA12) on the first of January. The new law doesn’t eliminate all of the tax increases that were scheduled to take effect.

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Source: Tax Foundation; Congressional Budget Office; Joint Committee on Taxation; Office of Management & Budget.

The payroll tax holiday was allowed to expire and the new Obamacare taxes still begin in 2013 increasing taxes by $161 billion (31% of scheduled increase). The bill also adds a new tax bracket for taxpayers with income over $400,000 ($450,000 for joint filers) and raises the estate tax to 40% for estates over $5 million. The new taxes are expected to raise another $70 billion. Here’s what the new tax rates are expected to look like:alt

Single Filers

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Joint Filers

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Source: CCH Tax Briefing, January 2, 2013

The President said repeatedly during the debate that no one was going to get everything they wanted in this bill. The final bill contains plenty of things to complain about for both Democrats and Republicans. The one provision we should all be able to rejoice over is the permanent fix to the Alternative Minimum Tax (AMT).

The AMT was originally designed by Congress in 1969 to ensure that wealthy individuals could not avoid income tax by exploiting loopholes in the tax code. Unfortunately, the AMT rules were not indexed for inflation. The Tax Relief Act of 2010 temporarily increased the AMT exemption amounts for tax years 2010 and 2011. ATRA12 patches the AMT for 2012 and provides a permanent ongoing fix by increasing the exemption amounts annually to inflation. The 2012 exemption amounts are $50,600 for single filers and $78,750 for joint filers. The 2013 amounts are projected to increase to $51,900 for single filers and $80,750 for joint filers. Without the AMT patch over 60 million taxpayers would have been subject to this tax in 2012. Unfortunately, the IRS estimates that many taxpayers may experience a delay filing their 2012 returns because the AMT patch was not put through before the end of the year.

The AMT fix provides a permanent solution to what has been a 10 year ongoing problem. However, many of the provisions in ATRA12 are temporary which continues the “patch and postpone” tax policy that makes long term tax planning so difficult.

Some of the popular tax provisions temporarily patched in the new law include:

Charitable IRA Distributions – The ability to make a Qualified IRA Charitable Distribution has been reinstated for 2013. This provision allows a taxpayer age 70 ½ or older, to give their Required Minimum Distribution (up to $100,000) directly to a charity without having to first record it as income. The rule will expire on December 31, 2013 unless Congress extends it again.

Deduction of state and local sales taxes – This provision allows taxpayers to elect whether to claim a deduction for sales tax or income taxes. This is very popular with taxpayers living in states with low or zero income taxes.

Above line deduction of qualified tuition expenses – Taxpayers are allowed up to a $4,000 above-the-line deduction for qualified higher education tuition and related expenses. Since the expenses that qualify for this deduction are the same as those that qualify for the education credits, taxpayers may qualify for both and will be required to choose between the two.

Tax planning will not be any easier this year. ATRA12 removes some uncertainty but a lot of temporary provisions remain. Taxpayers earning more than $200,000 ($250,000 for joint filers) will need to take into consideration the new Obamacare taxes and the itemized deduction phase-out reinstated in the new law. The biggest part of the tax increases were averted in this law but the fight over spending cuts has only been delayed until the end of February. The final compromise may still have an impact on 2013 taxes.

Rick’s Tips

  • 44% of the total “Fiscal Cliff” tax increases are still in effect after ATRA12.
  • A permanent AMT fix will avoid the last minute patches we have become accustomed to over the past 10 years.
  • The Charitable IRA Distribution was only reinstated through the end of 2013.

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