y the end of this year, tax laws that have created historically low rates for a long time will expire. Also, several popular deductions and tax credits will no longer be available. This situation has been referred to as the “fiscal cliff.”
And while other recent tax policies have been implemented to affect more of the wealthiest individuals and businesses, this change will have sweeping implications for everyone.
According to calculations by the Tax Policy Center, the average tax cost per household will increase by almost $3500, with middle-class tax payers expecting to see an average increase of $2000.
So, to give you an idea of what you can expect – if no action is taken by congress to address this issue – here are a few scenarios that can give you some perspective:
|Filing For Singles
Ron is single with an annual AGI of $60,000. And as most people do, Ron uses the standard deduction when filing his return.
After taking out a personal exemption of $3,850 – what is expected in 2013 – and a standard deduction of $6,050, Ron's taxable income is $50,100.
With the current tax laws, a portion of Ron’s income ($8900) would be taxed at just 10 percent, and his top rate would be 25 percent. When calculated, this would make him responsible for paying $8,465 in taxes.
However, if we go over the fiscal cliff, Ron's tax liability will be $863.50 higher based on these numbers.
The primary reason for this increase is that the tax brackets will change. This will leave more of Ron's income to be taxed at 15 percent, with his top rate being 28 percent.
|Filing For Married Couples
Sarah and Mike have two kids: an 8-year old a 10-year old. Both of them work, and they bring home a combined AGI of $175,000. Because they are still renting and do not yet have a mortgage, they will use the standard deduction.
With the current tax laws, four personal exemptions would add up to $15,400, and a standard deduction of $12,100 would leave them with $147,500 of taxable income. This would result in them having a tax liability of $28,803. But with a tax credit of $1,000 per child, their bill would be brought down to $26,803.
However, if we go over the fiscal cliff, Sarah and Mike will have a tax liability of $33,107. That’s a $6,304 difference! This is mainly because of the return of the marriage tax penalty – where couples have to pay more for filing joint returns instead of filing individually. Also, the tax credit for the children would return to being only $500 per child.
In addition, changes in the tax brackets would have an effect as well. Sarah and Mike will be in the 31% bracket – as opposed to the 28 percent bracket – if the tax cuts disappear.
|Dividends And Capital Gains Taxes
If you have investments in a taxable brokerage account, your tax bill next year will increase.
With the current laws, lower rates are applied to long-term capital gains and certain dividends, as opposed to being taxed at ordinary income rates. These rates are usually 15% for most taxpayers, while taxpayers in the lower 10 and 15 percent brackets don’t pay anything on their capital gains.
But if we go over the fiscal cliff, the capital gains rates will return to 35% for most investors, and all dividends will be taxed again as ordinary income.
|No More Payroll Tax Holiday
Everyone knows that payroll taxes come out of the check they take home. And among those withheld from the check are FICA taxes – Social Security and Medicare.
In order to give workers more money to take home – to give the economy a boost – the government provided a 2 percent reduction in Social Security taxes. This was called the “payroll tax holiday,” and has been in effect since 2011.
However, if we go over the fiscal cliff, this payroll holiday will expire, increasing taxes for all workers. But in particular, increase may be very large for high-income earners.
For example, if you make up to$113,700 next year, your taxes going to the retirement system will be $7,049.40. That's an increase of $2,425 compared to what you’d pay with the current laws.
|Other expiring tax breaks
In addition to the tax consequences of the fiscal cliff that we just mentioned, there are several others. These include:
- Reductions in savings from the Child Care Credit
- The $2,500 American Opportunity Education Credit will no longer be available for students. Instead, they’d have to settle on the $1800 Hope Credit.
- It will be more difficult for low income taxpayers to qualify for the Earned Income Credit, and the credit amount will be lower.
- More property left behind will be affected by the estate tax. Instead of the exclusion amount of $5.12 million, the threshold will be just 1 million. Also, the estate tax rate will increase from 35 to 55 percent.
- The amount of deductions that can be taken on Schedule A claims will be reduced by 3 percent.
- And so on….
It is critical for entrepreneurs and individuals to keep an eye on what happens with their taxes as these changes take place. Because taxes are probably your single greatest expense, it’s important to plan for taxes in order to mitigate the situation. For more ideas and advice on how to do handle these changes, you may call Marietta CPAs at (317) 216-1040.