Impact of Fiscal Cliff Tax Legislation Enacted into Law
The following are some quick highlights of the Fiscal Cliff Tax Legislation that was enacted into law Monday night. The legislation only addresses major tax issues, while raising the debt ceiling limits and preventing the automatic sequestration spending cuts from beginning will be dealt with over the next two months:
• Charitable Deductions: Good news is that the charitable tax giving incentives were not specifically capped and no changes were made to the exempt status or classification of charities, such as nonprofit arts organizations. While no changes have been made in this first round of fiscal cliff negotiations, tax reform revenue raisers are still on the table as Congress and the White House negotiate staving off deep sequestration cuts in the next two months. Americans for the Arts will continue advocating the importance of this issue on behalf of the nonprofit arts sector.
• Personal Exemptions and Itemized Deductions: Unfortunately, the new tax law does reinstate both the Personal Exemption limitation and the "Pease limitation," (named after former Congressman Donald Pease (D-OH)), which will reduce the overall amount of itemized deductions (including home mortgage, charitable, local and state taxes, etc) by three percent of only that amount that exceeds the threshold (but not to exceed 80% of total itemized deductions that would have been taken). These deduction limitations are not a cap and they only kick-in for married couples earning more than $300,000 and singles earning more than $250,000 annually.
Here’s how it works: If married taxpayers earn $1 million and have total itemized deductions of $190,000 (home mortgage interest, charity donations, state/local taxes combined) in 2013, they will not be able to deduct the full $190,000 from their income. They will only be able to deduct $169,000 ($190,000 - $21,000) because the PEASE limitation rule reduces the deduction by the equivalent of 3% of the amount of their income above the $300,000 threshold ($1 million - $300,000 = $700,000 is the amount above the threshold). The reduction would then be $21,000 ($700,000 x 3% = $21,000). These rules were in effect in the 1990’s, but had been temporarily phased out during the Bush-era tax cuts in the previous decade.
• IRA Rollover: extends for two years, retroactive to 2012, allowing donors age 70½ or older to donate to charities tax-free from their IRAs. Important note: donation deadlines have been extended by a month so that donors can designate their IRA distributions to a charity in January 2013, but still have the deduction apply to tax year 2012.
• Marginal Rates: Permanent extension has been made of the current Bush-era lower tax rates for families earning up to $450,000, and singles earning up to $400,000. However, for earners above these levels, their rates will increase to Clinton-era levels of up to 39.6 percent.
• Capital Gains/Dividends: The tax rate on capital gains and dividends will remain at 15 percent for earners with income up to the $450,000(families)/$400,000(singles). However, the rate permanently goes up to 20 percent for those earners above the threshold.
• Estate Tax: Permanently sets the estate tax at the current level with a $5 million exemption that is now indexed for inflation and a top tax rate of 40 percent.
• Alternative Minimum Tax: A permanent patch has been made to the AMT for upper-middle class earners so that it is now annually indexed to inflation.
• Payroll Tax Cut Holiday: This recession-fighting strategy that cut payroll taxes by two percent for the last couple of years in order to bolster take-home pay has now expired and was not renewed in 2013.