Fiscal Cliff Deal: Tax Implications

Even though President Obama indicated only last Friday that the fiscal cliff deal likely to be produced by the January 1 deadline would be a basic package, lawmakers managed to come out with a surprisingly comprehensive set of tax provisions, some with long-lasting effects.

Perhaps the most far-reaching is the permanent patch for the alternative minimum tax, which applies retroactively for 2012 and indexes the AMT for inflation to keep it from spreading to 30 million more middle-class taxpayers. That will make life easier for accountants and tax planners, not to mention lawmakers in Congress, who need to contend with patching the AMT year after excruciating year. The IRS too will be relieved, as it recently warned that unless the AMT is patched soon, tax season could be delayed until late March or beyond (see IRS Warns Congress Tax Season Might Be Delayed until March or Later without AMT Patch).

In addition, the income tax rates were also made “permanent,” or as permanent as anything can be as far as Congress is concerned. The tax rates will be basically the same as the Bush-era tax rates, with the addition of a top tax rate of 39.6 percent for single taxpayers who earn $400,000 of taxable income, $450,000 for married couples filing jointly, $225,000 for married couples filing separately, and $425,000 for a head of household. But unlike the original Bush tax cuts, these won’t sunset in 2010 and need to be renewed again, as they were at the end of 2010 and this past New Year’s Eve.

On top of that, the American Taxpayer Relief Act also provides a permanent rate of 40 percent for the estate tax, with an inflation-adjusted $5 million exclusion for the estates of decedents who pass away after Dec. 31, 2012. The bill also revives the personal exemption phase-out, or PEP, along with the Pease limitation on itemized deductions, but at higher thresholds than in the Clinton administration.

Not only did the bill deal with those thorny areas, but also a host of expiring tax cuts, traditionally known as the “tax extenders.” Several were extended through the end of 2017. Seemingly the only tax break that won’t be extended is the one on Social Security payroll taxes, which will return to 6.2 percent after a “holiday” of 4.2 percent for employees in 2011 and 2012.

“The rank and file will be affected by no extension of the payroll tax holiday, which will wipe out any gains they might have made by extending any Bush-era tax cuts,” said Bill Smith, managing director of the CBIZ MHM National Tax Office.

High-income taxpayers in particular will be seeing tax increases. “It will affect a lot of our clients at the upper end,” said Smith. “Those with taxable income over $450,000 are going to be negatively affected, both in terms of individual income tax rates, capital gains, qualified dividends, and the 3.8 percent Medicare tax, which will hit the over-$250,000 group. To me it’s a surprisingly comprehensive bill, though. There were a lot of things that got passed and extended that weren’t really discussed and were very vague leading up to the passage of the bill. I was happy to see that there were a lot of extenders that were extended that weren’t part of the Bush-era tax cuts.”

Smith believes the Section 179 small business expensing dollar limit of $500,000 is a big deal. “There are a lot of extensions that are good for business and individuals in terms of savings, so I was impressed with the comprehensiveness of what they were able to get done,” he said.

However, the bill was passed too late in the game to do meaningful tax planning for clients for this past year. “It’s a little hard to do 2012 planning when you pass the bill in 2013,” said Smith. “But if you want to make charitable contributions, either directly from your IRAs or take cash distributions after November 30, and give either one of those to charity by February 1, you can take a 2012 deduction,” he said. “As far as I can tell, that’s about all the 2012 planning you can do at this point.”

Congress also extended the ability to convert from a regular IRA to a Roth IRA without paying an early withdrawal penalty, he noted.

CCH principal federal tax analyst Mark Luscombe has mixed feelings about the bill. “The American Taxpayer Relief Act is nowhere close to the grand bargain once envisioned by the President and many lawmakers, but it’s a major plus for taxpayers that the 2001 and 2003 tax act changes have finally been made permanent after years of uncertainty,” he said in a statement. “Effectively, it’s a stop-gap measure to prevent the onus of the expiration of the Bush-era tax cuts from falling on middle income taxpayers. Congress must still address sequestration. And, Congress is likely to revisit tax policy and spending cuts when it tackles the expected increase on the nation’s debt limit in February.”

CCH has issued a tax briefing explaining the various provisions of the American Taxpayer Relief Act.

Janice Krueger, a subject matter expert on payroll and information reporting compliance at Greatland Corporation, which produces W-2 and 1099 compliance software, noted that many software providers have been in a holding pattern awaiting a decision from Congress on what to do about the expiring tax rates. The IRS finally released tax withholding tables on Monday just before the Senate voted to pass the fiscal cliff bill, which will cause the tables to quickly go out of date (see IRS Changes Income Tax Withholding Tables for 2013 to Reflect Expired Tax Cuts).

“On Monday the IRS released the 2013 withholding tax tables,” said Krueger. “However that was prior to Congress actually passing the fiscal cliff deal, so what they said when they released those tables was that guidance would have to be released if Congress acts on the fiscal cliff deal, which is in fact what Congress did. My guess is that the IRS will have to re-release the withholding tax tables. For right now what employers will have to do is they can use the 2012 tax tables, which would be closer to the taxpayers’ true tax liability, other than obviously those very high-income earners.”

The IRS issued a brief statement Wednesday afternoon promising further information soon. “The IRS is currently reviewing the details of this week’s tax legislation and assessing what impact it will have on this year’s filing season,” the IRS said in a statement, according to The Wall Street Journal. “The IRS will soon make available additional information on when taxpayers can start filing 2012 tax returns as well as updated withholding tables for employers and payroll companies.”

In the meantime, employers at least know that Social Security payroll taxes have reverted to 6.2 percent. “Generally most of the payroll industry should have been prepared to increase the Social Security tax rate to 6.2 percent because that really wasn’t a point of contention between either of the parties,” Krueger noted. “Payroll companies already should have incorporated that, but if they didn’t, they should be doing that. They do need to make that appropriate adjustment as soon as possible, but not later than Feb. 15, 2013. But if for any reason they have underwithheld the Social Security tax, if they did not increase it to 6.2 percent, they need to make that appropriate adjustment as soon as possible, but not later than March 31, 2013.”

Krueger anticipates the IRS will be able to turn around the new tax tables quickly. “It’s a lot easier to release the tables than to address all of the support that’s going to surround the questions related to it,” she pointed out.

One other big plus of the American Taxpayer Relief Act of 2012 is that it certainly has a better name acronym-wise (ATRA) than the earlier Bush-era tax cuts legislation, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 and the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003.

Tax preparers had better get used to talking with their clients about ATRA in the years ahead. At least it’s easier to pronounce than EGTRRA or JGTRRA.

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