The bill approved in Congress to avert the so-called fiscal cliff would bring the first major tax increase on high earners in 20 years.
While leaving income-tax rates in place for most Americans, taxpayers with more than $400,000 in taxable income or couples with $450,000 would see the top marginal tax rate rise to 39.6% in 2013 from 35% in 2012. For income earned below that level, the 2012 rates would be permanently extended.
Taxes on long-term capital gains, dividends and estates also would rise for wealthy taxpayers.
The House of Representatives passed the bill late Tuesday night, even though some Republicans in the House said the bill didn’t contain enough government-spending cuts. The bill had passed early Tuesday in the Senate. Any final version signed into law by President Barack Obama could look different.
According to the bill, Americans at all income levels would see a two-percentage-point jump in the employee portion of the Social Security tax. It will return to 6.2% in 2013 after a stimulus rate of 4.2% expires.
Looking Over the Fiscal Cliff
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For a couple with one child and $1 million of income, including $250,000 of itemized deductions, the tax increase from higher rates and other provisions taking effect next year would run almost $37,000 over what they paid in 2012, according to estimates made by Dave Kautter, an official with the Kogod Tax Center at American University.
“It would be higher if more of their income is from investments, both spouses work or they have more children,” said Mr. Kautter.
The bill includes some less-obvious tax increases as well. For instance, it revives two tax increases that lapsed in 2010 that will affect a large number of affluent earners, as opposed to just those earning millions of dollars.
One of these tax increases will be in the form of the personal exemption phaseout. That provision reduces or eliminates the benefit of the personal exemption. That exemption was $3,800 per person for most individuals in 2012. Under the bill it would phase out for couples with $300,000 or more of adjusted gross income, or singles with $250,000.
Another tax increase being revived is the “Pease” provision, a complex limitation on itemized deductions. Under the bill, it would eliminate up to 80% of deductions for couples above the $300,000 threshold, and singles above $250,000. The provision, named after former Rep. Donald Pease (D., Ohio), affects all deductions, including charitable donations and mortgage interest.
The formula, in effect, adds about one percentage point to the top tax rate, including the top rate on capital gains, tax experts said. As a result, “Many people who think they’ve dodged higher rates will actually have backdoor tax increases,” said Mr. Kautter.
For millions of wage earners, the most immediate effect of the bill would be the payroll-tax increase, which would reduce their take-home pay. For an individual earning the maximum 2013 cap of $113,700 or more, the increase would amount to nearly $200 per month.
Because of all the intricacies involved, it will take up to four weeks after a law is signed for many workers to know exactly what their 2013 take-home pay will be, according to Michael O’Toole, an official of the American Payroll Association, a group of 21,000 payroll managers. The 2013 tax-filing season also is likely to be disrupted by Washington’s wrangling. Normally it opens in mid-January, but this year it might be delayed till mid-February or later. As a result, many filers won’t be able to receive tax refunds as early as they normally do.
“Congress’s delays have pushed back the repayment of interest-free loans to the government for millions of taxpayers,” said Lawrence Gibbs, a former IRS commissioner now with the Miller & Chevalier law firm in Washington, referring to tax refunds. The average refund is approaching $3,000, according to IRS data.
The bill would raise rates on long-term capital gains and dividends for top-bracket taxpayers to 20% for 2013 from 15% in 2012. Meanwhile, the 15% rate would continue to apply to taxpayers in the 25%, 28%, 33% and 35% income tax brackets. People in the 10% and 15% brackets would continue to have a zero rate on capital gains and dividends.
The bill permanently and retroactively adjusts the alternative minimum tax—originally designed to limit deductions for the highest earners—so that millions of middle-income taxpayers wouldn’t be subject to it. The current fix expired at the beginning of 2012.
The estate- and gift-tax exemption would remain $5 million or more per individual. But the current 35% top tax rate on amounts above the exemption would increase to 40% in 2013.
Provisions allowing deductions for $250 of teachers’ classroom expenses, tuition and related expenses, and state sales taxes in lieu of state income taxes would be extended, as would the $100,000 charitable donation of IRA assets by account owners 70 l/2 and older.
The bill would extend for five years the American Opportunity Tax Credit. For many taxpayers this dollar-for-dollar credit is worth up to $2,500 and therefore the most valuable education benefit. It also would extend for five years the current versions of the Child Tax Credit and Earned Income Tax Credit, which are claimed by many lower-income workers making up to about $50,000.
The bill also includes a one-year extension of current “bonus” depreciation rules, which allow businesses to deduct up to 50% of the cost of a wide variety of property and equipment, excluding real estate.