The Fiscal Cliff Was Averted, But How Does This Affect My Taxes?

Local tax attorney, explains some of the highlights of legislation that was enacted in avoidance of the 'fiscal cliff.'

As most are aware, the recent theatrical showdown amongst our elected officials in Washington concerning the “fiscal cliff” went into last minute negotiations.  On January 3rd President Obama signed legislation to prevent the United States from going over the “fiscal cliff.”  Here are some highlights of the American Taxpayer Relief Act of 2012:

  • Income Tax: A new higher individual income tax rate of 39.6%, up from 35%, will apply to married couples earning $450,000 and above; head of household taxpayers earning $425,000 and above; and single taxpayers earning $400,000 and above. These threshold amounts will be indexed for inflation. 
  • Capital Gains and Dividends: A new higher capital gains tax rate of 20% will apply to long-term capital gains and qualifying dividends for taxpayers in this new 39.6% bracket.    The 15% capital gains rate will continue to apply to capital gains and qualifying dividends for those taxpayers in the 25%, 28%, 33% and 35% income tax brackets.  Further, those taxpayers in the 10% and 15% tax brackets will continue to have a 0% capital gains rate on capital gains and qualifying dividends.
  • Estate, Gift, Generation-Skipping Tax:  For estate, gift and generation-skipping tax purposes, the exemption amount will continue to be $5,000,000 (adjusted for inflation); however, the maximum estate tax rate is permanently increased from 35% to 40%.
  • Social Security Tax: Lawmakers failed to extend a temporary 2% cut in the employee’s portion of Social Security Tax.   Accordingly, Social Security Tax will increase from 4.2% to 6.2% of wage income, up to a cap of $113,700.    This aspect of the legislation will pose the largest impact on the average American taxpayer.
  • Alternative Minimum Tax (AMT): Lawmakers permanently indexed AMT for inflation.   AMT was originally enacted in 1969 in an effort to tax the wealthiest of taxpayers.   AMT was not indexed for inflation.  Had this not been rectified, sources estimate that over 34 million taxpayers would have been unfairly subject to AMT. 
  • Exemptions and Deductions: Lawmakers permanently reinstated the phase-out of personal exemptions and overall limitation on itemized deductions for married taxpayers filing jointly and with $300,000 or more of adjusted gross income, heads of household with $275,000 or more of adjusted gross income, single taxpayers with $250,000 or more of adjusted gross income and married taxpayers filing separately with $150,000 or more of adjusted gross income.  
  • Tax Credits/Tax Cuts:  The Bush-era tax cuts will be preserved for all taxpayers earning less than $400,000.  Further highlights regarding tax credits/incentives are: 
  • The American Opportunity Tax Credit for higher education will be extended an additional 5 years through 2018.
  • The Earned Income tax credit for certain qualifying individuals will be increased.
  • Credits and incentives extended through the 2013 tax year will include: above the line deductions for teacher expenses, relief from cancellation of indebtedness income derived from the sale of a principal residence, parity for employer-provided mass transit benefits, deduction allowance for mortgage insurance premiums, election to deduct state and local sales taxes, deduction for qualified education expenses, and tax free distributions from IRA’s that are distributed for charitable purposes.  Certain business tax credits/incentives are also extended through the 2013 tax year including research credits, new market credits, energy tax incentives and others.

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