President Signs Eleventh-Hour Agreement To Avert Fiscal Cliff

The tax side of the Fiscal Cliff has been averted.  The U.S. Senate overwhelmingly passed legislation to avert the so-called fiscal cliff on January 1, 2013 by a vote of 89 to 8, sending the American Taxpayer Relief Act of 2012 (HR 8, as amended by the Senate) to the House, where it was similarly approved on January 1, 2013 by a vote of 257 to 167.  The American Taxpayer Relief Act allows the Bush-era tax rates to sunset after 2012 for individuals with incomes over $400,000 and families with incomes over $450,000; permanently patches the alternative minimum tax (AMT); revives many now-expired tax extenders, including the researchtax credit and the American Opportunity Tax Credit; and provides for a maximum estate tax of 40 percent with a $5 million exclusion.  The bill also delays the mandatory across-the-board spending cuts known as sequestration.  President Obama signed the bill into law on January 2, 2013.

IMPACT.

Individuals with incomes above the $450,000/$400,000 thresholds will pay more in taxes in 2013 because of a higher 39.6 percent income tax rate and a 20 percent maximum capital gains tax.  Nevertheless, all taxpayers will find less in their paychecks in 2013 because of what the American Taxpayer Relief Act did not include:  the new law effectively raises taxes for all wage earner (and those self-employed) by not extending the 2012 payroll tax holiday that had reduced OASDI taxes from 6.2 percent to 4.2 percent on earned income up to the Social Security wage base ($113,700) for 2013.

COMMENT

Although these rates are now made permanent, nothing would stop Congress from reconsidering the entire tax rate structure again in the future, as part of overall tax reform or even earlier as debt ceiling negotiations get nder way shortly. 

CAUTION

Installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale,  Thus, the capital gains portion of payments made in 2013 and later is now taxed at the 20 percent rate for higher-income taxpayers.