TAXMAGEDDON & THE FISCAL CLIFF AVOIDED?

Technically the country did go over the fiscal cliff at the stroke of midnight on New Year's Eve. Then Congress passed new legislation in the wee hours of January 1, 2013 in effect catching us before we went splat at the bottom of the cliff. Whether of not this constitutes avoidance of Taxmageddon and the fiscal cliff is a matter of opinion.

While the new law does make permanent the Bush era tax rate cuts for those making less than $400,000, as of this writing (January 7, 2013) Congress has yet to address the federal debt ceiling, the looming across-the-board spending cuts required under sequestration, and the Obama administration has already indicated that they want to raise taxes even further.

TAX BREAK EXTENDERS

Items affecting 2012 returns

These are provisions that actually expired at the end of 2011 and therefore had the potential of adversely impacting your 2012 tax return due 4/15/13. As expected Congress has allowed some of these items to expire, while extending or renewing others retroactively to January 1, 2012.

• Sales Tax Deduction. Extended thru 2013. Taxpayers will still be able to deduct state & local sales taxes on their 2012 and 2013 returns.
• Teacher Classroom Expense Deduction. Extended thru 2013. This $250 adjustment to income remains available for 2012 and 2013 returns regardless of whether a taxpayer itemized or took the standard deduction.
• Tuition Deduction. Extended thru 2013. This above-the-line deduction for college tuition without having to itemize is still applicable to 2012 & 2013 returns.
• Foreclosure Relief. Extended thru 2013. Most cancellation of debt results in taxable income to the borrower. Historically this has included home foreclosures. However after the real estate crash of late 2008 an exception was made for most taxpayers whose homes were lost in foreclosure. Most taxpayers will still be exempt from paying taxes on cancellation of qualified principal residence indebtedness.

• Alternative Minimum Tax (AMT) exemption amount.  Permanently changed retroactive to Jan. 1, 2012. Since the AMT exemption amount has not been indexed to automatically adjust for inflation since its inception in 1969, Congress had to "patch" it every few years in order to avoid having it affect increasing numbers of taxpayers due to inflation. The new legislation is a permanent fix which set the exemption amounts at $78,750 for marrieds and $50,600 for singles and then indexes them for automatic inflation adjustments. Even if you do not get slammed by this tax increase, a letter from the Acting Commissioner of the IRS to Congress warns that up to 100 million taxpayers may not be able to file their returns until late March 2013 due to the IRS needing to reprogam its computers as a result of Congressional inaction. This does not mean you should delay coming in for your tax preparation interview. The information your preparer collects during the interview is from the past year and will not change after year-end. Basically your return will be "sitting on the shelf" waiting for the IRS to give the green light that it is finally ready to process your return. For a general explanation of how the AMT works, see this article on Forbes magazine website.

   

Items effective January 1, 2013

These items will affect your 2013 tax return due 4/15/14.

• Child Tax Credit. The $1,000 per child amount has been extended permanently.

• Itemized Deduction cap reinstated. The cap on total itemized deductions for higher income taxpayers which was eliminated under the Bush tax cuts was reinstated effective Jan. 1, 2013. High income taxpayers (married couples earning over $300,000 or singles over $250,000) will have their otherwise legitimate itemized deductions limited.

• Cap on Personal & Dependent Exemption amount returns. Under the Bush tax cut plan all taxpayers got to exempt the same amount of income per person ("claiming" yourselves and your dependents) regardless of income. This provision was allowed to expire so higher income taxpayers ($300,000 married or $250,000 single) will not get to claim their full exemption amount.
  

NEW TAXES

This section includes both new taxes under "ObamaCare" (Affordable Care Act of 2010) and increases in taxes due to the expiration of those portions of the Bush tax cuts affecting higher income taxpayers.

ObamaCare 2013 Taxes

• Medical Expense Deduction.The floor for medical deductions (sometimes referred to as a "haircut") was raised from 7.5% of income to 10% starting January 1. This means that only those qualifying medical expenses exceeding 10% of income will be deductible. Ironically this "tax on the sick" is being used to fund ObamaCare.
• Medical Devices Tax. This new 2.3% tax applies to most medical devices. Even your kid's braces. This new tax is levied upon the manufacturer, who of course will pass it along to you, the consumer. This tax is calculated on gross sales, meaning the tax is incurred even if the device maker is losing money.
• Flexible Spending Accounts.These plans are also known as Section 125 or Cafeteria Plans. They allow employees to have monies withheld from their paycheck on a pre-tax basis (like a 401(k) plan contribution) which is then used to reimburse the employee for their qualifying medical expenses. Many taxpayers use them to cover routine medical expenses such as doctor visits, prescriptions, the kids' braces and eyeglasses. In some cases, additional educations expenses related to austism were considered as qualifying expenses as well. ObamaCare limits these plans to $2,500 per year (while no legal limit existed before, most employers limited there plans to $5,000).

• Medicare Tax Increase.The 1.45% Medicare Tax will increase by 0.9% for couples with combined incomes of more than $250,000 ($200,000 for single filers).

• Medicare Surtax on Investment Income. ObamaCare imposes a new 3.8% tax on investment income of couples earning more than $250,000 ($200,000 for singles). This is in addition to the regular income tax. Investment Income includes interest, dividends, and capital gains including any portion of the gain on the sale of your personal residence that is not excludable (profits over $250,000 for singles or property not otherwise meeting the criteria). Combined with the repeal of Bush tax cuts for higher income taxpayers, this brings the tax on investment income of top earners to 43.4%

   

Partial Repeal of Bush Tax Cuts

• Income Tax rates. The lower tax rates for lower and middle income taxpayer under the Bush tax cuts have been made permanent. However for singles earning more than $400,000 or joint filers making more than $450,000 their tax rate has increaed from 35% to 39.6%.

• Marriage Penalty. The 2001 law intended to eliminate higher taxes for married couples as compared to two single taxpayers has been allowed to expire as of year end.

• Dividends. The 15% top rate on dividends remains the same for lower and middle income taxpayers. The rate for married couples earning $450,000 or more or singles earning more than $400,000 takes a jump from 15% to 20% effective 1/1/2013. However, this income is also subject to the new Medicare surtax discussed above, adding another 3.8% to these rates for those earning more than $200,000 single/$250,000 joint.

• Captial Gains. The maximum rate for long-term capital gains jumps from 15% to 20% for taxpayers with AGI over $400,000 or $450,000 for singles and joint filers respectively. However if you are fortunate enough to be a higher earner subject to the Medicare Surtax on investment income (see above), your rate would increase to 23.8.

Other Tax Increases

• Social Security payroll tax. The employee's shares of this tax will go back up to 6.2% from the 4.2% workers have been paying under Obama's stimulus plan. That's an extra 2% off the top compared with 2012.

• Estate ("Death") Tax. Only change in the exemption amount is the annual inflation adjustment. The first $5,250,000 of a decedent's estate is exempt from taxation. However the top tax rate on estates exceeding the $5.25 million threshold will jump from 35% to 40%.
• Gift Tax. The annual exclusion amount increased by $1,000 for 2013 to $14,000 per donor per donee.