As part of our normal tax planning updates at our firm, we had a two hour presentation on how the Fiscal Cliff may affect some of our taxpayers. As many of you know by now, on January 1, 2013 the Bush and Obama related lower tax rates are scheduled to expire along with many other programs designed to save taxes. Additionally, alternative minimum tax (AMT) relief for this year is still not in effect which may subject many millions of taxpayers to the AMT for the first time.
One of the slides that was presented showed the effects of this "Fiscal Cliff" on a sample taxpayer. This taxpayer had wages of $400,000, interest income for $100,000, qualified dividends of $100,000 and long-term capital gains of $100,000.
Under 2012 tax laws, their federal income tax liability would have been $190,000. With the new 2o13 laws (unless changed), their income tax increases by $60,000 to $250,000. This is a roughly a 31.5% tax increase.
The primary increases relate to the increase of the tax rates and related compression of the tax brackets and the taxing of qualified dividends at ordinary tax rates. Here is a recap of the relevant changes:
- Employee FICA on wages (reflects expiration of 2% payroll tax cut) - $2,200 increase
- Tax on qualified dividends - $24,600 increase
- Tax on long-term capital gains - $5,000 increase
- Phase-out of personal exemptions - $1,500 increase
- Compression of tax brackets/increase in rates - $13,500
- 3.8% Medicare surtax on passive income - $11,400 increase
- 0.9% Medicare tax - $1,800 increase
All of these increases add up to the overall increase of $60,000. Also, the taxpayer had itemized deductions, another tax increase of around $4,000 would probably have resulted.
We will have many of our taxpayers in similar situations and this is what they will face in 2013 in changes are not made. With some planning, we can minimize some of these tax increases, but many may be beyond our control.
What will it mean to your taxes?
Read More: Fiscal Cliff Example #2