What does the Fiscal Cliff Deal Mean to Your Income Taxes?

American Taxpayer Relief Act of 2012Updated Fiscal Cliff Deal Calculator

The theater (crisis) is over for now and a last-minute agreement was made in Congress.  What is harder  to believe? The 154 page document was given to the Senate 3 minutes prior to their voting on it or that President Obama went on vacation and used an absentee “autopen” to sign the Act?

In either case, the best news is that income taxes will remain the same for most people. More good news is that many of these rates will be permanent.

The bad news is that Capitol Hill had a golden opportunity to begin to address our ridiculous government spending problem and failed to do so. As a nation, we are VERY FINANCIALLY ILL. Under President Obama, our government has been spending over $1 trillion per year (illness -= over $16 trillion in debt) more than it brings in via tax revenue and did NOTHING to slow their spending (illness/debt getting worse).  Look for this to be the next financial crisis as the government has to renegotiate its annual budget, meaning it has to ask Congress to let them borrow more money to pay for their over-budget spending.

What the Deal Means to You:

Income tax brackets

Single taxpayers earning less than $400,000, married couples making less than $450,000, and heads-of-households filers making less than $425,000 will pay the same income tax as they did last year. But taxpayers earning more than those amounts in each filing category will face an income tax rate of 39.6% in 2013, up from last year’s rate of 35%.

Alternative Minimum Tax

The fiscal cliff deal raises the exemption for the AMT and pegs it to inflation, eliminating a long-standing headache for taxpayers.  Under the new deal, 2012 income of up to $50,600 will be exempt from the AMT, a threshold that will be tagged to inflation going forward. The nonpartisan Tax Policy Center calculates that about 4 million tax payers owed extra money under the AMT in 2011 when the threshold was about $48,000. The number would have ballooned to more than 31 million for 2012 if Congress had failed to act. Read the Tax Policy Center’s analysis

Capital gains and dividends

Taxes on capital gains and dividends for most investors will remain the same in the aftermath of the fiscal cliff deal. For individuals earning more than $400,000, rates on both dividends and capital gains jump to 20% from 15%. (In addition, as part of the deal to pay for the Affordable Care Act, those making more than $250,000 will also pay an additional 3.8% on investment income, including both dividends and capital gains.) The upshot is that for the highest earners both dividends and gains will be taxed at 23.8%.

Capital gains and dividends

Taxes on capital gains and dividends for most investors will remain the same in the aftermath of the fiscal cliff deal. For individuals earning more than $400,000, rates on both dividends and capital gains jump to 20% from 15%. (In addition, as part of the deal to pay for the Affordable Care Act, those making more than $250,000 will also pay an additional 3.8% on investment income, including both dividends and capital gains.) The upshot is that for the highest earners both dividends and gains will be taxed at 23.8%.

Roth IRA conversions

A provision in the bill makes it easier for investors to roll a 401(k) or 403(b) into a Roth IRA. Like the other plans, a Roth is a tax-advantaged retirement accounts. The big difference: 401(k) investors contribute pretax dollars, but pay taxes when they withdraw money in retirement. Roth IRA investors pay tax on that income up front, but can withdraw money later tax-free.

Why does it matter when you pay? Savers that expect to pay higher rates in retirement — because they expect overall taxes to rise or expect to be wealthier — may want to get the tax payment out-of-the-way sooner rather than later. Since most employers offer 401(k) plans, workers typically don’t have a choice about which type of plan works best for the bulk of their savings. Previously, they could convert their 401(k) to a Roth IRA, but only if they left their job or were old enough to start making retirement withdrawals. The new rules will allow other savers to make conversions, if their plan is set up to accommodate them.

While the move may be applauded by investors who will get extra say in how they save for retirement, it’s also a quick-fix revenue generator for the government. Account holders who convert traditional retirement accounts into Roth IRAs have to pay taxes on their balances when they convert – taxes they would otherwise be deferring. A new wave of conversions could spell a revenue windfall for Uncle Sam, although of course it would lower tax receipts in the future.

Payroll taxes

The payroll tax holiday ended with the new year. As a result, employees will contribute a larger share of their paycheck to Social Security in 2013. The temporary lower rate, which most tax experts did not anticipate would be extended in the fiscal-cliff deal, will rise from 4.2% to 6.2%, the level it stood at before the holiday was enacted. The Social Security program taxes up to $113,700 of wages, so those earning that amount or more will pay $7,049.40 in 2013, compared to the $4,775.40 they would have paid last year. Under the new rate, employees earning a salary of $100,000 this year will pay $2,000 more in 2013 ($166.67 more per month), while people making $60,000 will pay $1,200 more ($100 more per month).

Estate tax

In 2012, estates of up to $5 million per person were exempt from federal estate tax. Amounts above that threshold were taxed at 35%. The Congressional deal affirms that threshold, while also indexing it to inflation. However, it raises the top tax rate to 40% from 35%

There is more to this Bill and you should strategically direct your investments to minimize your tax bill. 

There is no need to pay more than you need to.

 

Source: Market Watch – What cliff deal means for your taxes

More detailed Report About American Taxpayer Relief Act of 2012



About Brad Rosley

Brad Rosley, CFP®, is the founder and President of FFG which opened in Glen Ellyn, Illinois in 1996. He has been a Certified Financial Planner since 1990 and helping individuals with their financial decisions for over 25 years. Ask Brad your financial and investment questions!

Subscribe

Enter your email address to receive
FREE updates from Life Planning Today and a FREE eBook "9 Ways to Minimize Income Taxes".
(We respect your privacy)

, , , , , , ,

No comments yet.

Leave a Reply

Financial Advisor Blog Network