Watching Out for the CliffPosted by Chad Bordeaux
Tuesday, October 23rd, 2012
Ordinarily, we use these posts to discuss fun items related to taxes and finances. We know that you can read the usual boring articles about the usual boring tax topics pretty much anywhere else. And most of you are happy to let us worry about “the details.”
Every so often, though, we need to discuss more serious issues, even if it’s just to let you know that we’re on top of them. That’s the case today with the so-called “fiscal cliff” — Federal Reserve Chairman Ben Bernanke’s clever term for what happens on January 1, when a bunch of current tax rules expire, and some new rules take effect. Here’s a quick rundown of what to expect:
• The Bush tax cuts expire. That means the top rates on ordinary income goes from 35% to 39.6%; the top rate on capital gains goes from 15% to 20%; and the top rate on qualified dividends jumps from 15% to 39.6%. Much of the debate over tax rates focuses on income at the top. But the expiration of the Bush tax cuts affects all of us. The lowest 10% rate will disappear entirely, and everyone who actually pays income tax will pay more.
• The 2011-2012 payroll tax cuts expire. That means Social Security and self-employment taxes go up by 2% on all earned income up to $113,700. Two percent may not sound like a lot — but it means higher taxes for about 163 million working Americans.
• New taxes imposed by the 2010 “Obamacare” legislation take effect. The Medicare portion of Social Security and self-employment taxes goes up from 2.9% to 3.8% on earned income topping $200,000 ($250,000 for joint filers). And there’s a new 3.8% “Unearned Income Medicare Contribution” (which sounds so much better than “tax’) on “net investment income” (interest, dividends, capital gains, rents, royalties, and annuities) over those same amounts.
• The Alternative Minimum Tax exemptions revert back to where they stood in 2000. Under current law, those exemptions aren’t adjusted for inflation. So, every couple of years, Congress “patches” the system by temporarily raising the exemptions to where they would be if they were indexed for inflation. The AMT currently hits about 4½ million Americans — but without the “patch,” that number explodes to 33 million.
• Oh, and don’t think dying solves your tax problem. That’s because estate taxes, which currently start at 45% on estates over $5 million, will jump to 55% on estates over just $1 million.
So, January 1 is our fiscal cliff, and we’re hurtling towards it like Thelma and Louise. What can we do? Well, plenty of legislators have proposed extending part or all of the Bush tax cuts, extending the payroll tax cuts, patching the AMT, and raising the estate tax exemption. But actually passing anything will be a challenge — Congress has passed just 132 bills this year, and 20% of those were to name post offices!
The partisan gridlock has many observers convinced that we’ll actually go over that fiscal cliff. (Maybe it’ll be like those old Road Runner cartoons, where the coyote runs off a cliff and keeps right on going, just fine, until he looks down. That’s when he realizes he’s standing in thin air, then plummets 1,000 feet to the bottom of the canyon.) If that winds up being the case, we may see Washington wait for the election results and pass something noncontroversial like the AMT patch before the end of the year. Then in 2013 they’ll pass legislation extending at least part of the Bush tax cuts and make it retroactive to January 1.
We’re not writing today to take sides on any of these issues, or tell you where taxes should go. But we want you to know that we’re watching everything closely to help you make the most of your opportunities and avoid land mines where possible. And remember, we’re here for your family, friend, and colleagues, too!