The “Fiscal Cliff” is a hot topic in the news right now. For most Americans, the increase in taxes will be the most significant impact if Congress allows us to fall over the “cliff”. The concern is that most taxpayers will pay significantly more in taxes starting on January 1, 2013 as several legislative acts, from the Bush-era and the Obama-era, affecting the tax code are set to expire.
The list is long, but listed below are some key tax breaks that could go away if Congress fails to act:
The Payroll Tax Holiday. The 2% Social Security “tax holiday” for employees will end, which will require employees to pay the full 6.2%. If you are self-employed, this means the Social Security portion of the Self Employment tax reverts back to 12.4%, up from the current 10.4%.
Individual Income Tax Rates. Ordinary income tax rates will increase for most individual taxpayers beginning in 2013:
1) Currently, the lowest tax bracket is 10%. That will disappear and the lowest rate will now be 15%.
2) If you are taxed at a 25% rate, this will increase to 28%
3) If you are taxed at a 28% rate, this will increase to 31%
4) If you are taxed at a 33% rate, this will increase to 36%
5) If you are taxed at a 35% rate, this will increase to 39.6%
The “Marriage Penalty” Returns. A marriage penalty occurs when a married taxpayer files under “joint” status but actually pays more than if he/she filed as an individual. In 2012 the “Marriage Penalty” is actually lower than past years due to a tax relief that was implemented during the Bush era tax cuts. If this tax provision is not extended by the end of the year, then the standard deduction will decrease in 2013, from $11,900 to $9,900* and could result in a marriage penalty for some filers.
Capital Gains and Dividends. For 2012, the maximum tax rate for long-term capital gains and qualified dividends is 15%. It is 0% for certain low-income investors. Beginning in 2013, the maximum rate for long-term capital gains will increase to 20%. It will increase to 10% for low-income investors. Meanwhile, for filers with higher incomes, qualified dividends will be taxed at ordinary income rates reaching as high as 39.6% (see above).
Note: If Congress fails to take action as the year-end approaches, investors who were otherwise considering selling appreciated stocks or securities in early 2013 should give additional consideration to selling in 2012 to take advantage of the lower rate, assuming they will have held the asset for longer than one year.
* This calculation is based on the 2012 standard deduction for a single filing status which is currently $5,950.
Reduction in Itemized Deductions. Under current law, itemized deductions are not subject to any overall limitation. If the Bush-era tax cuts expire, an overall limitation on itemized deductions for higher-income taxpayers will once again apply.
Section 179 Deductions. Currently, a small business can write off a maximum of $139,000 of qualified property, which includes machinery, equipment, and other tangible personal property rather than depreciating the asset over time. The maximum amount is scheduled to drop back to $25,000 in 2013.
Bonus Depreciation Deductions. As a complement to taking the Section 179 deduction, you may also qualify for 50% bonus depreciation on qualified new property placed in service in 2012. Without any extension, bonus depreciation will disappear completely in 2013.
Note: Business owners should consider placing qualified assets into service in 2012 to take advantage of the immediate tax benefit of the Section 179 and/or Bonus Depreciation deductions.
Other Changes Affecting Individuals
Medical and Dental Expense Deduction. As part of the Patient Protection and Affordable Care Act (sometimes called Obama Care), the threshold for claiming the itemized medical and dental expense deduction is scheduled to increase from 7.5 to 10 percent of Adjusted Gross Income. The 7.5 percent threshold will continue to apply through 2016 for taxpayers or spouses who are 65 and older.
Student Loan Interest Deduction. This currently allows for a deduction of up to $2,500 for interest paid on “qualified educational loans”. Beginning in 2013, it will apply only to interest paid during the first 60 months in which interest payments are required. Today, no such time limitation applies. Fewer families will qualify for the deduction in 2013 since the “phase-out” for the deduction begins at lower income levels.
Higher Education Credit. Parents who send their children to college can claim (subject to certain restrictions) the American Opportunity Tax Credit. The maximum credit for 2012 is $2,500 but is reduced to $1,800 for 2013.
Credit for Household and Dependent Care Expenses. Popular with working parents, the maximum creditable expenses will decrease from $3,000 to $2,400 (for one qualifying individual) and from $6,000 to $4,800 (for two or more individuals).
Child Credit. The maximum credit will decrease from $1,000 to $500 per child and cannot be used to offset Alternative Minimum Tax liability.