On New Year’s Day, Congress approved legislation to address the year-end tax hikes and spending cuts ominously dubbed the “fiscal cliff.” The agreement will stabilize tax rates that had been uncertain until now. It also delayed for two months the sequester deal agreed to in 2011 that imposes cuts of $55 billion to defense spending and $55 billion to non-defense spending. Those automatic cuts are now set to take effect March 1, the same time the nation’s debt ceiling will need to be raised to avoid default.
Stay tuned for another high-stakes showdown in the coming weeks, as Congress debates the need for raising the debt ceiling, cutting spending and reforming entitlements. In the meantime, here are some key elements of the American Tax Relief Act of 2012 that may impact your income and your investments in 2013:
Income taxes. All working Americans will see increased FICA withholding from their paychecks in 2013. The employee portion of the Social Security contributions will go up 2% (returning to pre-2011 levels) to 6.2%, with expiration of the payroll tax holiday.
Income-tax rates for individuals earning more than $400,000 and couples earning more than $450,000 will also increase to 39.6%. Income tax rates for those earning less than these levels will remain the same.
Capital gains and dividends taxes. Taxes on capital gains and dividends will be held at their current levels of 0% for those at or below the 15% marginal tax bracket (an estimated $36,250 individual / $72,500 joint) and 15% for individuals making less than $400,000 and households with income of less than $450,000. Taxes will increase to 20 percent for those with income above these levels.
Estate and gift taxes. The estate tax will rise to 40% from its current 35% level, with the first $5 million in assets exempted. The deal also raises the gift tax to 40%.
Exemptions and deductions. The new act phases out personal exemptions and limits itemized deductions for adjusted gross income over $250,000 (individual) and $300,000 (joint). The phase-out is a 3% reduction for each dollar over the limit (not to exceed 80%) with a net effect being another 3% of your income at marginal tax rate for those affected.
Retirement accounts. The new law permits 401(k) plan participants to convert their plan to a Roth plan, under which contributions are taxed going in and withdrawals are tax-free. The result is a short-term revenue boost now and more tax-free savings accounts.
It also extends for 2012 and 2013 the tax provision for IRA charitable rollovers that expired in 2011; this allows individuals over the age of 70½ to rollover up to $100,000 from an IRA directly to a charity.
Muni bonds. Income earned from municipal bonds will remain tax-exempt.
Alternative Minimum Tax fix. As part of the fiscal deal, the Alternative Minimum Tax (AMT) will be permanently indexed to inflation.
Sources: The Tax Foundation, National League of Cities, Schwab Center for Financial Research