Congress Avoids Fiscal Cliff And Passes First Major Tax Increase in Almost Twenty Years

Posted on January 3, 2013


ImageEarly Tuesday morning, the U.S.  Senate passed a bill aimed at averting spending cuts and tax increases that comprised the dreaded “fiscal cliff.”  House Republicans were extremely critical of the bill for not including enough spending cuts.  However, the House approved the bi-partisan legislation under the extreme pressure of trying to avoid the fiscal cliff and indications from Senate Democrats and Republicans that that the Senate would not entertain a modified bill.  This showdown is one of many in the coming year as Congress must tackle increasing the debt ceiling and the expiring government spending bill in the next few months as well as long term projects such as reform of the Internal Revenue Code and entitlement reform.

Naturally, each party is claiming some kind of victory with respect to the legislation.  Republicans are claiming victory because certain tax cuts enacted in 2001 and 2003 were made permanent.  One top Republican noted that this part of the legislation represents the first step of tax reform.  The Democrats are claiming victory because this legislation represents the first real tax increase in twenty years—something the Republicans were desperately trying to prevent.Key provisions of the new legislation include:

  • Applies a new top income tax rate of 39.6% on household incomes over $400,000 for individuals and $450,000 for married couples filing jointly.  Expiring Bush-era lower income tax rates for household incomes under $400,000 for individuals and $450,000 for married couples filing jointly are made permanent.
  • The tax rate on capital gains and dividends will permanently be set at 20 percent for those with incomes above the $400,000/$450,000 threshold.  The tax rate on capital gains and dividends will remain at 15 percent for most other taxpayers.
  • The Personal Exemption phase-out will start at household incomes of $250,000 for individuals and $300,000 for married couples filing jointly.
  • The itemized deduction limitation will start at household incomes of $250,000 for individuals and $300,000 for married couples filing jointly.
  • Makes permanent the existing $5 million exemption amount for estate and gift tax.
  • Increases top estate tax rate applicable to estates over $5 million from 35% to 40%.
  • Federal unemployment insurance will be extended for 1 year for approximately 2 million Americans.
  • The Alternative Minimum Tax received a permanent patch.
  • The Earned Income Tax Credit, the Child Care Tax Credit, and the American Opportunity Tax Credit will be extended for 5 years.
  • The payroll tax holiday will expire.

Numerous friends and clients have inquired regarding the new law’s provisions applicable to estate taxes, so we will expand on the above information.  As stated above, the new law makes permanent the $5 million dollar per person exemption.  This exemption amount will continue to be indexed for inflation each year (the exemption amount for 2012 was indexed to $5.12 million per person, for example).

While the new law increases the top rate applicable to estates of more than $5 million, it continues the concept of portability.  This means that a surviving spouse can use his or her deceased spouse’s unused exemption amount in addition to his or her own exemption amount to protect assets passed at the surviving spouse’s death.

The new act also provides that the estate and gift taxes will remain unified, meaning that an individual’s full $5 million exemption amount can be used during lifetime or at death.  Prior to 2011, the gift tax exemption amount remained at $1 million even when the estate tax exemption amount went up to $2 million and then $3.5 million, which meant that gifts during life in excess of $1 million required the payment of gift taxes even though an individual could give more than $1 million free of estate taxes if that gift took place at death.  Keeping the exemptions unified makes the same exemption from taxes apply whether a gift is made during life or at death.

While the increase in the top estate rate is certainly not welcome news, there are at least a few positives we can take away from the new legislation:  (i) the $5 million per person estate tax exemption amount did not decrease, (ii) taxpayer favorable concepts such as portability and the unified estate and gift tax credit have been retained, and (iii) taxpayers now have some certainty when it comes to estate and gift tax planning.

Brooke Everley
Everley Law, LLC

Russell M. Cunningham, IV
Cunningham Firm, LLC

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