The "Fiscal Cliff" and Post-Election Tax Planning for 2012 and 2013

Posted on Saturday, December 1, 2012

With the election over and the "Fiscal Cliff" looming, it is a good time to consider all of the potential tax changes coming at the end of the year. Many of these potential changes are the result of the Budget Control Act of 2011, a compromise reached by the President and Congress at the end of last year. Under the Act, if Congress cannot find a permanent fix for the rising deficit, a number of tax increases and spending cuts will automatically become effective as of the end of the year.

At this point, it is not clear whether the President and Congress will reach a compromise to resolve the climbing deficit before the end of the year. If they are able to reach a compromise, it is anyone's guess what that compromise may be. They may be able to develop a long-term solution, or they may just agree on another short-term fix. It is possible, though, to consider what will happen if a compromise is not reached. This article outlines those possibilities. 

Many of the tax increases that will become effective at the end of the year if Congress does not act are the result of the expiration of Bush era tax cuts enacted in 2001 and 2003. Ordinary income tax rates for individuals will increase, with the highest marginal tax rate jumping from 35% to 39.6%. This individual tax rate is also applicable to income earned by many entities subject to pass-through tax treatment. Top capital gains rates will increase from 15% to 20%, and dividends will be taxed at ordinary income rates. The maximum estate tax rates will increase from 35% to 55%, and estates in excess of $1 million will be subject to the estate tax. 

Additionally, millions of Americans may be subject to the alternative minimum tax, or AMT, for the very first time if Congress does not act. This is because the AMT "patch," a fix that Congress has used several times to deal with the fact that the AMT has not been adjusted for inflation since it was enacted in the 1960s, is set to expire at the end of the year. While the AMT has historically applied only to higher-income taxpayers, with the expiration of the AMT patch it may apply to families with annual incomes as low as $75,000. 

The payroll tax holiday, which reduced payroll taxes from 6.2% to 4.2% in 2011 and 2012, is also set to expire at the end of this year if Congress and the President cannot agree on its extension. The result for many employees will be additional taxes. With all of the other tax changes set to take effect at the end of the year, the increase in payroll taxes has not appeared to be a priority among members of Congress. 

At the same time, certain tax increases will take effect as a result of the Affordable Care Act.  The Medicare tax, which currently applies to wages at a rate of 2.9%, will increase to a rate of 3.8% and apply to both wages and investment income for certain higher-income individuals. 

With all of the uncertainty and possible outcomes over the next few weeks, you may be wondering what you can do. For some taxpayers it makes sense to consider making large gifts or restructuring business investments before the end of the year. If you have any questions about your individual tax situation or what the expiration of tax cuts may mean for you, do not hesitate to contact any member of the BrownWinick Estate Planning Group