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Fiscal Cliff Bill Passes: American Taxpayer Relief Act of 2012 (H.R. 8)

This article was written by in Taxes. 16 comments.


Late last night, the United States House of Representatives passed is designed to avoid the fiscal cliff, the bill already approved by the Senate that avoids the fiscal cliff, the automatic tax rate reversion and spending cuts agreed to last year by Congress. With recurring drama every few months, the government seems to be taking cues from the reality television playbook, where those with the power to do so overtake the news cycle with a manufactured conflict. Others do it for the ratings and advertising revenue, but the reasons behind the Congress’s use of drama to attract attention to itself baffle me.

As much as I’ve tried to avoid talking about the so-called fiscal cliff, its provisions are important to money management, and thus I can’t ignore it completely. The other melodramatic political deadlines, the debate over raising the debt ceiling and the passing of the annual budget that allows Congress to continue operating, which are generally nothing more than pure theatrics, there was a bigger question as to whether a sharply divided Congress would be able to come together to avoid the fiscal cliff.

H.R. 8, the American Taxpayer Relief Act of 2012, passed the House with a vote of 257 to 167, after earlier passing the Senate 89 to 8. The President is expected to sign the bill into law today. Michael Kitces has already prepared an excellent article about the financial implications of the Act.

Marginal tax rates

The bill is good news for the middle class. The law makes the lower tax rates enacted during President George W. Bush’s tenure permanent. Recently, Congress has had to fight every year to extend the tax cuts, but this will no longer be necessary. Of course, “permanent” is a misnomer. A new bill at any time could change the tax rates, but without an expiration date, no action is necessary to keep them in force. The above applies to all but the top tax bracket. The top rate is reverting back to the higher rate, as it was before the Bush-era tax cuts.

The top marginal tax rate has been 35% in recent years, and in 2013, it would have affected taxpayers earning $398,350 and up, whether filing single or married. (Keep in mind that’s a modified adjusted gross income, your income after all deductions have been accounted for.) That bracket has been bumped up by the Act to $400,000 for single taxpayers, keeping a sliver of taxpayers in the 33% tax bracket. The highest tax rate is back to 39.6%, so that effects only the income above the $400,000 threshold. For couples, that threshold is $450,000, not $400,000. For heads of household, the threshold is $425,000.

Keep in mind how marginal tax brackets work. If you “fall in the top tax bracket,” you don’t owe 39.6% on all of your income. You owe that rate only on the income above $400,000 (or $450,000 or $425,000), and lower tax rates on the income that falls within the lower tax brackets. Here are the 2013 marginal federal income tax rates.

Taxes on investment income

The American Taxpayer Relief Act makes permanent a lower tax rate on capital gains and dividends, but wealthy investors might not be happy with the change of the lower rate from 15% to 20%. Most investors will still pay 15% on long-term capital gains and qualified dividends, but for income falling in the top tax bracket, the rate will increase to 20%. This will have an effect on those who earn most of their money from investing rather than working as an employee or a contractor.

The investment tax increase also affects professional money managers, whose income is considered “carried interest,” and who are basically employees of a mutual fund but receive regular income in a favorable tax situation.

Social Security and Medicare

As I’ve already mentioned, the payroll tax, which has been temporarily reduced by two percentage points over the past few years, has been reinstated. The American Taxpayer Relief Act did not extend this tax cut. That will result in an effective reduction in take-home pay for employees, consultants, and the self-employed, all other things being equal.

At the same time, some investors might find an additional tax on their net income. To help fund Medicare, everyone earning over $200,000 (or $250,000 if filing jointly) will be required to pay an additional 3.8% tax on the lesser of their modified adjusted gross income or net investment income. This is in addition to the 15% or 20% tax on long-term capital gains and qualified dividends and any other income tax. The tax is phased in, so the exact amount you’ll pay depends on your income. (This is an example of why the applications that handle the calculations automatically, like TurboTax, are so valuable, as are qualified tax professionals.)

Estate taxes

The Act increases the top estate tax rate from 35% to 40%. Most estates will continue to be exempt from estate taxes as the tax doesn’t kick in until beyond the first $5 million in inheritance.

Other provisions of the American Taxpayer Relief Act

There are a number of other provisions included in the American Taxpayer Relief Act which have a smaller affect on the average taxpayer. Some deductions and credits have been extended or made permanent. For example, he American Opportunity Tax Credit, which is a $2,500 credit for college expenses, and the Child Tax Credit and the Earned Income Tax Credit, have all been extended through 2017.

Read the full text of the Act

You can read the full text of H.R. 8 here.

The drama isn’t over

Now that Congress has experienced its biggest takeover of the public consciousness, expect to see more partisan drama over upcoming debates like the debt ceiling, which is always a fierce debate but is always resolved with a resolution to raise the debt ceiling in order to allow the government to continue to operate. Congress’s own operating budget is another annual threat to politicians’ ability to do their jobs, yet it is always pushed forward for another year.

Nevertheless, with artificial or arbitrary deadlines, it seems the government is more likely to work together and put aside their differences in order to get things accomplished. It also helps raise awareness of issues and encourages the public to talk and debate about proposed laws. I see this as a byproduct of our culture that feeds off drama as a form of entertainment.

The American Taxpayer Relief Act will actually reduce future drama by eliminating the need to renew tax rates every year, but I am confident Congress will find a way to create more needless conflict, encourage the public to become even more partisan and unlikely to listen to other people’s perspectives, and enforce the idea that something is only good if it benefits oneself.

Photo: Flickr
GovTrack

Updated January 4, 2013 and originally published January 2, 2013. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 16 comments… read them below or add one }

avatar krantcents

I expect cutting spending will be far worst thanks to reduced revenue! Obama did not get as much revenue enhancement as he wanted which means there will probably be more spending cuts. The drama continues!

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avatar SteveDH

It might be important to note that the 3.8% tax on Investment Income and Capital Gains kicks in only when your AGI is over $200k and $250k (Individual/Married). It also doesn’t apply to investment earnings within a deferred account because earnings aren’t reported as taxable and withdrawals are treated as ordinary income.

Your use of the word Drama is too kind – try silliness, daftness, pointlessness, idiocy, etc etc.

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avatar jim

The 3.8% Medicare tax is part of Obamacare and that ONLY impacts higher income earners. Its not all investments. Its only for households over $200k single / $250k married

Ref: https://www.fidelity.com/viewpoints/personal-finance/new-medicare-taxes

The new law also permanently patches the Alternative Minimum Tax (ATM). It makes the higher exemptions permanent and adds an automatic inflation adjustment.

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avatar Luke Landes ♦127,373 (Platinum)

Thanks Jim and SteveDH for pointing that out — I’ll clarify the text above.

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avatar Jacob

Glad the child tax credit and AOTC are extended, for my tax clients’ sake. I hate being the bearer of bad news, so this is a relief. The 2% bump, I can deal with. Now I can actually start writing my tax cheat sheets down because they voted on something. I do hate all this last-minute crap, though…

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avatar Kevin

So the net net is although the wealthy americans will pay more in taxes, all of us in middle class get screwed by Obama as well and pay more in taxesl. We now have to pay 2% more in taxes due to social security and the payroll tax. What a crock.

He says he’s for the poeple yet we go more into debt, and those of us who don’t make 400K+ a year still get stuck with higher taxes.

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avatar crashdamage1957

@ Kevin… no, we dont have to pay 2% MORE in taxes..we got to pay 2% LESS in payroll taxes for the past two years, as it was intended as a temporary measure from the get go.

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avatar Jonas

The estate tax is a bit more complicated than that — each person has $5 million exempt from transfer, be it by gift or death. For example, if you die single and your estate is worth $6 million but you made $4 million in gifts during your lifetime, you only have a $1 million in credit remaining and your estate — not your heirs — will owe tax on the remaining $5 million. This is notable because if you can afford it, the tax-wise move it to make gifts while you’re alive because the gift tax is tax exclusive.

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avatar Apex ♦478 (Nickel)

What does that mean to say the gift tax is tax exclusive and why does that make it a tax wise move? It seems to me to come out the same whether you gift it pre-death or use your exemption after death.

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avatar Jonas

Let’s say that you have $10 million, the exemption is $5 million, the tax rate is 40%, and there are no deductions. If you died with all $10 million, $5 million would be taxable, and your estate would owe $2 million.

Now let’s say you gifted away $7 million during your lifetime. You used up your $5 million exemption, so you owe tax on the $2 million, which is $800,000. Now you die, and your Estate is $2.2 million — $10 million, minus the gift you made, minus the tax you paid. Your tax on your Estate is $880,000, for a total in tax paid of $1.68 million.

The difference is that you aren’t paying the transfer tax on the gift tax you already paid (the $800,000). Again, the circumstances have to all line up for it to work, but it’s an advantage if you’re going to have a taxable estate and can afford to make lifetime gifts. Note: the GST Tax may apply as well.

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avatar Apex ♦478 (Nickel)

I see what you mean now. That’s a good point. Most people don’t realize its the giver who pays the gift tax, not the receiver. That’s what makes this work.

If your estate doesn’t have appreciated assets this could be a good idea. However if you hold assets with considerable capital gains that have not yet been taxed, you get a stepped up basis at the time of inheritance. However if you gift out appreciated assets the receiver’s basis is the original basis of the giver so for appreciated assets it is a big benefit to receive the stepped up basis if the receiver has any intention of ever selling those assets.

This kind of stuff is why estate planning is so important if you have a large estate. The tax laws just make things far too complicated.

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avatar Jonas

Correct. The best thing to gift is cash.

avatar Ceecee ♦796 (Dime)

At least they finally did something. Finally. Not everyone got all that they wanted, that is what compromise looks like. I hope that they will address the budget cuts and the debt ceiling before the eleventh hour. This last minute action is getting to be a bad habit.

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avatar Luke Landes ♦127,373 (Platinum)

There’s no stopping it now. The media love this kind of high drama. From soap operas to 24 hour news to reality television, the government is learning how to keep the public enthralled.

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avatar Damian D.

I was watching CNN and the outcome looks so different depending on who is analyzing it. Republican analysts see it as win because they limited the amount of taxes that were raised, while Democrat analysts see it as a win because they limited the amount of cuts that were erased. It is quite frustrating to see that they can still cannot compromise. What’s your favorite way to keep up with the Fiscal Cliff negotiations?

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avatar Mason J Krangle

Over the last few months, there has been a lot of discussion about the “fiscal cliff,” and the significant tax increases that many Americans can expect in 2013 as a result of expiring tax provisions. No matter what decisions are made, it’s fairly certain that many of them will be short-term fixes and that more tax law changes are looming in our future. We will have to address the BIG “ticket” issues eventually.

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