What the fiscal cliff deal means for your taxes
Answers to your questions about tax rates, capital gains, the alternative minimum tax, as well as a guide to which tax credits were extended or made permanent
This post is by Laura Saunders of The Wall Street Journal.
Here are questions and answers about what the new tax agreement means for millions of Americans. For a plain-language summary of the bill, click here.
What happens to individual tax rates for 2013?
For most people, individual tax rates will stay the same as last year. However, for the wealthiest there’s a new permanent top rate of 39.6%, up from 35% for 2012.
The threshold for the top rate is $450,000 of taxable income for married couples filing jointly and $400,000 for single filers.
What about tax rates on investment income?
The bill does not tax dividends at the same rate as wages and other ordinary income, a change that was set to occur with the expiration of the 2001-03 tax changes. Instead, it leaves dividends in the same category as long-term capital gains.
But the bill does permanently raise rates on long-term capital gains and dividends for top-bracket taxpayers. People who owe at the 39.6% level for income tax will pay 20% on all their net long-term gains as opposed to 15% in 2012.
Meanwhile, the 15% rate will continue to apply to taxpayers in the 25%, 28%, 33% and 35% income-tax brackets, and people in the 10% and 15% brackets will continue to have a zero rate on capital gains and dividends.
Did Congress fix the alternative minimum tax (AMT)?
Yes, just in the nick of time. Lawmakers permanently indexed the AMT for inflation and made the change retroactive to the beginning of 2012, when the last inflation adjustment expired.
If this fix had not been made, the AMT would have applied to 34 million taxpayers in 2012. First passed in 1969, this tax was originally intended to apply to wealthy people using many tax strategies, but over time its reach has spread, especially to people in high-tax states. It also would have disrupted severely the coming tax-filing season.
What happened to the 2012 payroll-tax cut?
Lawmakers allowed a temporary cut of two percentage points in the employee’s portion of Social Security to expire. The levy will rise to 6.2% of wage income, up to a cap of $113,700, meaning that an individual earning the maximum amount will owe about $200 a month more in payroll tax for 2013.
For millions of Americans, this will be the biggest effect of the bill.
Are there other important income-tax changes?
Yes, and they affect the affluent as well as the very wealthy. Lawmakers permanently reinstated the Personal Exemption Phaseout (PEP) and the “Pease” provision, both of which lapsed in 2010. Both apply to married joint filers with $300,000 or more of adjusted gross income ($250,000 for singles).
PEP will cut or eliminate the value of deducting personal exemptions for taxpayers above those income thresholds. In 2012, the personal exemption was $3,800 for most individuals. In 2013, the exemption will phase out completely at about $420,000 of AGI for couples.
The Pease provision, named after former Rep. Donald Pease, D-Ohio, is a complex limitation on all itemized deductions -- including charitable donations and mortgage interest -- that will eliminate up to 80% of deductions for taxpayers above the thresholds. This phaseout’s net effect is to add about one percentage point to the top tax rate, including the top rate on capital gains, say experts.
What happens to the estate and gift taxes?
The estate- and gift-tax exemption will remain $5 million or more per individual -- not the $3.5 million sought by President Obama. But the current 35% top tax rate on amounts above the exemption will increase to 40%.
The exemption will remain indexed for inflation, so the 2013 amount will be more than the 2012 exemption of $5.12 million.
In addition, the estate and gift tax will remain “unified,” meaning that an individual can use the entire exemption to make gifts while alive. In some previous versions of the law, the gift-tax exemption was much smaller than the overall estate-tax exemption, meaning that most of the exemption couldn’t be used until death.
The “portability” rules will also be permanent. This provision allows a deceased spouse’s estate to transfer to the surviving spouse any unused portion of the $5 million exemption.
Was “bonus” depreciation renewed?
Yes, as an economic stimulus. Lawmakers passed 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.
What about “extenders”?
Congress extended many other temporary provisions. Some expired at the beginning of 2012 and some at year-end; lawmakers made some extensions permanent but not others, with some details still unclear.
Permanent extensions include:
- Expanded dependent care credit.
- Expanded adoption tax credit and other adoption assistance.
- The 2001 modifications to the child tax credit.
- Expanded Coverdell education accounts.
- Expanded benefits for employer-provided education assistance, expanded student loan interest deduction and scholarship tax exclusion.
- Marriage-penalty relief for the standard deduction, the 15% bracket and the earned-income tax credit.
Temporary extensions include:
- IRA charitable contribution. This highly popular provision allows IRA owners who are 70 1/2 and older to contribute up to $100,000 of account assets directly to a charity and have it count as part or all of their required minimum distribution.
- According to the Senate summary, many individuals who took a distribution in December 2012 will be able to contribute that amount a charity and have it count as a rollover. (Two years, through 2013)
- The American Opportunity Tax Credit. For many taxpayers this credit is worth up to $2,500 and is therefore the most valuable education benefit. (Five years, through 2017)
- The teachers’ classroom-expenses deduction of up to $250. (Two years, through 2013)
- Tax relief on canceled or forgiven mortgage debt. (Two years, through 2013)
- Deduction for state and local sales taxes in lieu of state income taxes. (Two years, through 2013)
- Deduction for qualified tuition-related expenses. (Two years, through 2013)
- The 2009 modifications to the child tax credit. (Five years)
- Third-child Earned Income Tax Credit. (Five years)
- Parity for employer-provided mass-transit benefits with parking benefits. (Through 2013)
- Special rules for conservation donations. (Two years)
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