Over lunch, the day after the election, my husband brought up the “f” word. You know, the one I’ve thus far been refusing to say (hint: it rhymes with “biscal piff”). He had been reading the news and was wondering how badly this would affect us. I could barely choke down my broccoli as he read an article touting the end of the world as we know it.
It wasn’t the last time I would hear that commentary this week. I received a number of emails, calls and yes, even Skype messages, passing along articles, links, and tidbits about the imminent demise of the country due to the upcoming tax *insert your dramatic weather word of choice here*. To paraphrase the brilliant Mark Twain, those reports are greatly exaggerated.
Let me see if I can separate reality from hype. I’ll also add in a few big predictions for what that’s worth.
First, unless something happens between now and the end of the year, taxes are going up. Let’s not hide from that. This was slated to happen no matter who was elected on Tuesday. It was going to happen because we have had the most ineffectual Congress in recent history. And the chances that changing before 2013? Consider this: the House returns to session in mid-November before breaking again on November 17. After returning for a week or so, they’ll take a week off for Thanksgiving and then try to adjourn mid-December. How much do you think they’ll get done? Exactly.
So for now, we’re stuck with the hand we’re dealt. And that means taxes are going up. If nothing happens between now and the end of the year, those tax increases and changes for individuals will include the following:
Federal income tax rates head north. Federal income tax rates are slated to go back up at the end of 2012; the cuts were initially set to expire in 2010 and were temporarily extended for two years due to legislation signed in December 2010. Without any Congressional action, those cuts will simply expire. What does that mean for most taxpayers?
To keep it simple – since this is meant to be a quick look – I’ve only included the brackets for individual taxpayers. Basically, almost everyone is slated to take a hit. My big prediction: in the name of compromise (*cough*) the cuts will be extended for most taxpayers with some wiggling at the top (or other concessions).
No more payroll tax holiday. The payroll tax cut was supposed to be a “temporary” cut in your withholding to make up for the loss of the Making Work Pay Credit which expired in 2010. The cut was intended to last just one year, went into effect in 2011, and was extended into 2012. The cut officially reduced payroll tax contributions on the employee side of Social Security by 2%: instead of paying in at 6.2% for Social Security taxes, contributions, which were still subject to the cap, are 4.2% for 2012 (the self-employed also got a break): it is not on tap for 2013. My big prediction: the cut is allowed to expire but expect another fun “holiday”/credit in its place, enacted sometime in 2013, officially annoying the new IRS Commissioner.
Drop in federal estate tax exemption, increase in tax rates. Beginning in 2013, assuming no change the federal gift, estate, and GST tax exemptions will also revert to the pre-2001 numbers.
According to the Tax Policy Center, only 3,300 taxpayers – or roughly .001% of the nation’s population – will owe federal estate tax in 2012; that number will increase dramatically to 52,500 taxpayers – or just under .02% of the nation’s population – who will owe federal estate tax. So, definitely more people subject to federal estate tax in 2013 – though, statistically, probably not you. My big prediction: the exemption stays put, but the portability (fancy tax term for allowing married couples to combine exemptions) disappears and the rates go lower.
Alternative Minimum Tax (AMT) Increase. Oh, the AMT. The AMT is the most confusing of taxes – and the most bungled in Congress. The AMT was meant to stop the extremely wealthy from using large tax deductions to avoid paying taxes. The AMT is not, remarkably, indexed for inflation. That means two things: 1, any increases in the exemption amount have to be approved by Congress every.single.time and 2, tweaks in the Tax Code (like the tax cuts) are essentially meaningless to those subject to the AMT. What Congress has done to “fix” this is to put a band-aid on the problem, referred to as a “patch” every year; basically, the exemption is boosted. Without the boost, more folks are subject to the AMT – and by more folks, I generally mean at least 20 million. I’m not kidding about the number – at least 27 million taxpayers will be subject to the AMT in 2013 if nothing happens this year. It’s a problem every year (I’ve been whining about it since at least 2005) and was a central feature in the 2008 election when McCain (like Romney) suggested eliminating the AMT altogether (he later backed off of the idea). My big prediction: expect another temporary patch.
Capital Gains Increase. Capital gains tax is the tax paid on the difference between the sales price of an investment asset and the basis (usually, the cost). It can be tricky since there are a lot of exemptions (as with the sale of your home) as well as special rules that apply to the type of asset and the holding period (basically, how long you own the asset). When you hear folks talk about capital gains tax rates, they’re usually talking about long-term capital gains tax rates since those are considered tax-favored (short term capital gains are generally taxed at ordinary income tax rates). Capital gains rates are low now – at 15% – which is considered favorable for investments. Without any action by Congress, those rates will go back up to the Clinton-era 20%. My big prediction: In a nod to Reagan, capital gains tax rates will be allowed to increase if income tax rates stay low.
PEP and Pease Limitations Reinstated. Currently, as income increases, personal exemptions and itemized deductions generally decrease. The personal exemption phaseout (PEP) lowers the value of the personal exemption for married taxpayers with incomes beginning at $261,650 and fully phases out the exemptions when income reaches $384,150. The Pease limitations, named after former Senator Don Pease (D-OH), limits itemized deductions at the same thresholds. PEP and Pease limits were slated to be reduced beginning in 2006 and eliminated in 2010; as with the other tax cuts, the elimination of these limits was extended through the end of 2012. If nothing happens between now and the end of the year, the limitations return at the original thresholds (indexed for inflation). The result of those changes is basically an increase in the top marginal tax rates (those at 36% and 39.6%). My big prediction: the limitations are reduced or eliminated. Despite being a variation on plans pitched by both President Obama and Mitt Romney, tinkering with deductions aren’t popular and would be vehemently opposed by, among others, charitable organizations and the real estate community.
Increase Medicare Tax. Under the current system, when you work, you pay into the Medicare system as part of your federal payroll taxes. You pay 1.45% of your pay and your employer pays in 1.45% for a total contribution of 2.9%. Unlike Social Security, there is no income cap, so all of your wages are subject to the tax; the cap on Medicare wages was removed as of January 1, 1994. Beginning in 2013, the Medicare tax imposed on high-income taxpayers on the employee side will be increased by 0.9% – to 2.35% – for wages over the income thresholds (individual taxpayers reporting income over $200,000 and married taxpayers filing jointly reporting income over $250,000); amounts under the threshold will still be taxed at 1.45%. By way of example, if a single taxpayer earns $500,000, the first $200,000 is taxed at 1.45% and the next $300,000 is taxed at 2.35%. Self-employed taxpayers will have the same limitations. My big prediction: this stays as part of a compromise.
New Medicare Tax. In 2013, Medicare tax – the portion of FICA taxes that workers pay in addition to Social Security tax – will be imposed at a higher rate of 3.8% on investment/unearned income for high-income taxpayers (same numbers as before). Investment income includes exactly what you’d think but excludes distributions from qualified retirement plans, including pensions and IRAs. My big prediction: this disappears as part of a compromise. Realtors hate it. Top taxpayers hate it. Wall Street hates it. Easy target.
Increased Medical Deduction Floor. Medical expenses that are reported on Schedule A of your 1040 are deductible in 2012 to the extent that they exceed 7.5% of your adjusted gross income (AGI). Beginning in 2013, taxpayers who itemize their deductions can only deduct those medical expenses which exceed 10% of AGI (those 65 and older keep the 7.5% floor until 2016). That means, for example, if you have an AGI of $100,000 – and are under the age of 65 – you cannot deduct medical expenses until you have spent $10,000 out of pocket. In that instance, if your expenses for the year total $9,500, you may not take the deduction; if your expenses total $12,000, you may deduct $2,000 (the amount more than $10,000). My big prediction: the floor rises as part of a compromise that leaves the mortgage deduction untouched. About 6% of taxpayers actually take the medical deduction and almost every President and presidential candidate from Bush to Obama to Romney has suggested some form of limit on the deduction.
There, in a nutshell, are most of the significant tax changes for individual taxpayers. I know there are other tax changes that are considered imminent and “new” by folks like Breitbart even when they’re not. Those including the tanning tax (“new” in 2010 and dramatically affecting Snooki); the Cadillac tax imposed on insurers, not individual taxpayers, for high premium insurance plans (slated to go into effect in 2018); and the individual mandate tax on the uninsured (beginning in 2014). While some of these will impact individual taxpayers, they won’t affect a majority of taxpayers, though they tend to make a nice headline or two.
Snark aside about the crazy commentary floating around, I do think that we have some serious fiscal challenges again. The Congressional Budget Office (CBO) has warned, in its report (downloads as a pdf) that, with the current numbers, we’re on track for an economic slowdown – including higher unemployment and lower taxable incomes – even though the deficit will be cut nearly in half. It’s a worrisome trade-off. We can’t keep borrowing and raising the debt ceiling to plug the hole but reducing tax revenues too much will likely have the effect of increasing the deficit.
So what’s the fix? The major fix is offering consistency. We don’t need temporary patches and extensions. We need some comprehensive reform. Part of the fear over falling over the er, you know what, is the concern about the unknown. How can individuals and businesses plan without any direction? It’s like teaching my kids to ride a bike and then saying, just before they take their first ride without me, “Surprise! You’re riding a scooter instead!”
It’s simply not fair to taxpayers, to tax professionals, to IRS (yes, I’m sticking up for them, too) and for financial advisors to constantly be in the position of having to shift gears and hedge bets (no, not that kind of hedging). We need clear direction. You want to avoid going over a real fiscal cliff? *There, I said it.* Try giving folks a road map.
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