The House, the Senate and the President are always wrangling over legislation. This did not begin in 2008 or in the recent election season. However, it seems that otherwise boring tax legislation has become more interesting to the average people.
Publications, news agencies, TV and internet shows make money when people read their publications or watch their show. They often select controversial topics and then promote them with grabby headlines. As of the time that this article is being written, the grabby headlines often include the words “fiscal cliff”. As intended, this evokes an image of economic doom.
Tax Laws With An Expiration Date:
Many Federal Tax laws are set to expire at the stroke of midnight on December 31, 2012 (along with prescribed budget cuts).
Here is a brief summary of just some of what is in store for us beginning in 2013 if the Federal Government cannot get its act together:
- The top Marginal Income Tax Bracket on Taxable Ordinary Income will go up from 35% to 39.6%.
- The 0% and 15% Long-Term Capital Gain rates will expire and be replaced with Long-Term Capital Gains rates of 10% or 20%.
- The special 15% top tax rate on Qualified Dividends will no longer apply. All taxable Dividends will once again be included with the taxpayer’s other Ordinary Income and taxed at whatever rates that turns out to be.
- The temporary Social Security Tax Holiday will expire. For 2011 and 2012, the employee’s portion of Social Security Tax was reduced from 6.2% to 4.2%. Beginning in 2013, employee’s wages (up to $113,700) will once again be subject to the regular/full 6.2% Social Security Tax.
- The Child Tax Credit will be reduced from $1,000 per eligible child to $500.
- The Child and Dependent Care Credit will be reduced from a maximum of $3,000 per child (up to 2 qualifying children totaling $6,000) to $2,400 per child (up to 2 qualifying children totaling $4,800).
- Certain Taxpayers with high Adjusted Gross Income (AGI) will once again have a portion of their Itemized Deductions and Personal Exemptions “Phased-Out”.
- Over the past decade, the AMT exemption has been increased based upon an inflation factor. The 2012 inflation adjustment has not yet been made. Accordingly, if no action is taken AMT will hit more taxpayers and will do so beginning in the 2012 tax year.
- Debt forgiven in connection with the foreclosure of a principal residence will once again be considered to be taxable income unless the taxpayer is insolvent or in bankruptcy.
- The maximum Section 179 expense for purchases of qualifying business assets will be reduced from $139,000 to $25,000.
New Tax Laws, Fresh Out of The Box:
Separate from the tax laws that come into effect as a result of laws that are expiring, there are a few brand new taxes. These include, but are not limited to expanded Medicare taxes.
Under the current law (as it has been for many years) 1.45% of an employee’s wages are withheld as a Medicare Hospital Insurance tax. Employers must then match this. The total combined Medicare Hospital Insurance is 2.9% (1.45% + 1.45% = 2.9%).
The following is new for 2013:
- The Medicare Hospital Insurance tax rate on employee’s wages (and taxpayers subject to Self-Employment Tax) for certain higher income taxpayers will go up by .9%. This would bring the total combined Medicare Hospital Insurance relative to higher income taxpayers to 3.8% (1.45% +.9% + 1.45% = 3.8%).
This only applies to the extent that the individual’s total wages or Self-Employment Income exceeds the threshold amount. The threshold amounts are as follows:
- For people with a Filing Status of Married Filing Jointly: $250,000.
- For people with a Filing Status of Married Filing Separately: $125,000.
- For people with a Filing Status of Single, Head of Household or Qualifying Widow(er) with a dependent child: $200,000.
- The Medicare tax will be expanded beyond wages and could affect some higher income taxpayers with certain types of unearned income. Beginning in 2013 there will be a 3.8% “Unearned Income Medicare Contribution Tax”. For Individuals, this new surtax is 3.8% of the lesser of the taxpayer’s net investment income or the excess of Modified AGI over the threshold amount.
- Modified AGI is AGI with the foreign earned income exclusion and foreign housing exclusion added back.
- The threshold amount is $125,000 for taxpayers filing as Married Filing Separately, $250,000 for taxpayers filing as Married Filing Jointly/Surviving Spouse and $200,000 for other taxpayers.
- For example, Jordan and Aneliese file as Married Filing Jointly and have Modified AGI of $250,000. They are subject to no surtax regardless of their net investment income.
- For example, Jordan and Aneliese file as Married Filing Jointly and have Modified AGI of $310,000, which is comprised of $260,000 of combined wages and $50,000 of net investment income. Since their Modified AGI exceeds their $250,000 threshold, there will be a surtax to pay. The question now is how to calculate the surtax.
Their Modified AGI exceeds their threshold by $60,000 ($310,000 – $250,000 = $60,000). Since their $50,000 of net investment income is lower than the $60,000 that exceeds their threshold, the 3.8% is multiplied by the $50,000 of net investment income (i.e. the lower of the two). The Medicare surtax is $1,900 ($50,000 x 3.8% = $1,900).
One of 3 possible things will happen between the date that this has been written and January 1, 2013.
- The Federal Government does nothing, in which case the laws change as a result of the expiration of the current laws.
- The Federal Government enacts legislation that merely extends the current legislation (i.e. they kick the can down the road again).
- The Federal Government enacts new legislation that addresses the underlying issues rather than another short-term stopgap.
Even if legislation is not passed prior to January 1, 2013 the Federal Government can pass legislation that is retroactive to January 1, 2013. Further, the Federal Government can always pass new legislation no matter what they do now, or later.
No one can predict the future; particularly when it comes to the actions of the politicians in the Federal Government. However, the consensus seems to be that the Federal Government will get its act together enough to limit the negative consequences of the expiring tax laws. Of course, this might ultimately be done sometime in 2013, with the effective dates retroactive to January 1, 2013.
Accordingly, we could “fall over the cliff” on January 1, 2013 only to wake up later (after subsequent retroactive legislation) to find that it was all just a bad dream.
Copyright ©, Keith B. Baker – 2012
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