The Fiscal Cliff Act

Unless you were living on the moon this past week, you know that Washington policymakers finally reached a so-called "fiscal cliff" deal that avoids a sudden return to tax rates that are now more than a decade old.  But for some reason, news outlets have been a bit stingy about telling us exactly what's in the American Taxpayer Relief Act of 2012.

The good news is that our lawmakers are creeping closer to reality about how to define "the rich;" rather than $200,000 (single taxpayers) or $250,000 in adjusted gross income (joint returns), as specified in many prior proposals, "the rich" are now defined as making more than $400,000 (single) or $450,000 (joint).  For taxpayers whose income falls below those thresholds, the temporary Bush-era tax cuts have (for the first time) been made permanent, which means that for most taxpayers, the marginal tax rates will remain the same this year as they have been for the past two.   However, taxpayers who fit this new definition of "the rich" will experience a new 39.6% upper tax bracket.  They will also be required to pay taxes on capital gains and dividends at a 20% tax rate.  (The 15% rate still applies to taxpayers below the thresholds.) 

In addition, the Taxpayer Relief Act borrows something from the Clinton era tax code: itemized deductions and the personal exemption will once again begin phasing out for individuals with more than $250,000 in adjusted gross income, or couples with more than $300,000 AGI.  At $372,501 (single) or $422,501 (joint) of adjusted gross income, personal exemptions are phased out in their entirety.

The tax bill also makes permanent the current $5 million estate and gift tax exemptions ($10 million for couples), but raises the tax rate for money transferred to heirs above that amount from 35% to 40%.  And it offers a permanent fix to the perennial alternative minimum tax problem by inflation-indexing the threshold (currently $78,750 for joint filers; $50,600 for individuals) at which people have to calculate their AMT, exempting all but about 5 million taxpayers from this chore now and in the future.

Also eliminated: the two percentage point reduction in the Social Security payroll tax--a stimulus measure enacted in 2010, which is likely to be the biggest impact of the legislation on most taxpayers.  The payroll tax rises from 4.2% last year to 6.2% this year.

Finally, the new tax law makes $24 billion in federal spending cuts, while giving Congress two additional months to decide what to do about $109 billion of automatic spending cuts that were scheduled to begin taking effect at the start of this year.

You can expect those two additional months to be spent in partisan wrangling over where, exactly, federal expenses should be cut, and news outlets have been repeating over and over the fact that March 1 also happens to be the next time that Congress has to vote to raise the debt ceiling.  We don't know whether that next debate will spill over into tax rates once again, but we will be paying attention and will keep you posted.