Welcome back to Farm $ense. In what can be argued as typical Washington-style fashion, the U.S. Senate and House of Representatives passed a piece of legislation on January 1 that brought us back from the so called “fiscal cliff” at the last possible moment. Well, technically, we actually did go over the cliff before everything was signed, but it was signed to go into effect retroactively.
The ensuring legislation is titled The American Taxpayer Relief Act of 2012 – or ATRA. There are quite a number of provisions in the bill, some permanent, some temporary, and we’ll touch on a few that effect a large portion of Farmshine readers.
• Payroll tax expired. The temporary payroll tax holiday, which was a 2% reduction in Social Security tax for every employee regardless of income levels, has come to an end. Although it’s never fun to see our take home pay decrease, this payroll tax wasn’t necessarily a tax increase – just an expiration of a tax break in place since 2010.
Tax rate brackets (mostly) unchanged. Most taxpayers will continue to pay tax according to the same six tax brackets of 10%, 15%, 25%, 28%, 33%, and 35%. However, for individuals with income over $400,000 (or $450,000 for married couples filing jointly), their top tax bracket will increase to 39.6%.
• Limitations to deductions. For individuals earning $250,000 (or $300,000 for married couples filing jointly), certain exemptions and itemized deductions will be limited. This doesn’t necessarily change a taxpayer’s marginal tax rate, but it most likely does subject more income to taxation.
• Capital gain taxes made permanent. Taxpayers in the 10% or 15% tax bracket will continue to see a 0% tax on capital gains and dividends, and this is now permanent. Taxpayers in the 25%, 28%, 33%, or 35% will see a 15% maximum capital gains and dividends rate, also made permanent. However, taxpayers in the new 39.6% bracket will pay 20% on capital gains and dividends, a tax increase of 5%. As noted, these changes are now considered “permanent” and not subject to the sunsets that have created much uncertainty the past several years.
• Alternative Minimum Tax fixed. Another tax provision in previous years that was constantly uncertain was the alternative minimum tax (AMT). There were “patches” made almost annually, with the last one expiring at the end of 2011. These patches were designed to protect the number of households subject to the AMT, and the American Taxpayer Relief Act makes these patches permanent by making the exemption amounts indexed for inflation moving forward.
• Estate Tax made permanent. Possibly the biggest financial planning issue we’ve faced the past few years are the uncertainty around the Estate Tax, with more than a decade of estate and gift tax ambiguity keeping financial professionals busy. The Act makes permanent the $5M exemption amounts, which will now be indexed for inflation, and also permanently allowing for “portability” between spouses. The projected inflation adjustment for 2013 is projected to be $5.25, but will be finalized later this year. However, the taxation of amounts higher than the exemption increases from 35% to 40%.
There are numerous other planning issues included in this Act, and we will discuss any applicable ones with clients on an individual basis. But as a quick listing, other provisions include greater flexibility in Roth 401k conversions, increased standard deduction amount for married couples, expanded tax credit provisions related to dependent care tax credit, permanent adoption tax credit and child tax credit, higher limits and more generous rules of educational expense provisions, and charitable IRA distributions of up to $100,000 for IRA holders over age 70½ are able to be excluded from income.
Please consult a tax professional before making any tax related financial decision.
Up next in Washington? The debt-ceiling discussion, and it promises to be just as interesting as the talks leading up to the “fiscal cliff” fallout and the creation of the American Taxpayer Relief Act of 2012. Let’s hope Washington can come together and make decisions that truly make $ense for our country.
• Ron Bare is a representative of and offers securities through Securities America, Inc., Member FINRA/SIPC, and advisory services through Securities America Advisors, Inc. Bare Financial Services, Inc. and the Securities America companies are separately owned.