“...in this world nothing can be said to be certain, except death and taxes”

— Benjamin Franklin

On the Edge of the “Fiscal Cliff”

Posted by & filed under Estate Taxes.

What is the “Fiscal Cliff”?  A burgeoning federal budget with an almost $16 trillion deficit and several changes to the laws colliding all at the same time.   The Bush tax cuts expiring, the implementation of the new laws from the 2011 Tax Ceiling legislation ready to go in effect (the sequestration issue with automatic budget cuts going into effect), the changes from the Obama healthcare law, temporary payroll taxes expiring….

More than a dozen tax cuts are set to expire Dec. 31 and a couple of new taxes are scheduled to start with the new year. Combined, they would affect nearly 90 percent of taxpayers, from the very richest to the very poorest, with the typical household’s tax bill rising by about $2,000 in 2013, according to the nonpartisan Tax Policy Center.

Automatic spending cuts, related to the debt ceiling deal of 2011, could affect over a thousand government programs including Medicare and defense.  Inaction in Congress could result in what might prove to be the largest tax increase in history.

The Bush tax cuts are set to expire effective 12/31/2012, which will raise taxes by an average of 17 percent on ALL taxpayers, and very adversely raises taxes on working parents and high income investors (who will bear a 70 percent increase). Add about $285 billion in tax increases on individuals, about $75 billion on businesses, and the estate tax changes, and you have the biggest tax increase in history!

Some of the taxes that we could see a change to:

1. Estate tax exemption (will go to back to $1,000,000 and 55% based on pre-EGTRRA laws).

2. The generation-skipping transfer (GST) tax exemption is scheduled to lower to $1 million inflation indexed in 2013.  The tax rate will go up to 55% on gifts.  Capital gains rates go from 15%-20%.

3. Alternative minimum tax will affect 30 million people – up from 4.1 million currently.

4. Earned income tax credit.

5. Qualified dividend rates.

6. Marriage penalty relief.

7. American opportunity tax credit.  An additional 3.8 percent increase from the Affordable Care Act on high-income investors for interest, dividends and capital gains on unearned income for taxpayers with income over $250,000 ($200,000 if single).

8. A limitation on itemized deductions is also scheduled to kick in at the end of this year that could add another 1.2 percent.

9. Temporary payroll taxes are eliminated which will take a small 2% bite out of the average American’s paycheck.

10. Dividend income will no longer have preferential tax treatment, it will be assessed at the ordinary income tax rate.

11. Wages are subject to a 2.9% Medicare payroll tax with Workers and employers each paying half, or 1.45%.

12. 0.9% Medicare tax will be imposed on wages and self-employment income over $200,000 for singles and $250,000 for married couples, Trust and Estates income, and investment income (subject to certain rules).  (Charitable remainder trusts (“CRTs”) are exempt from this tax. This, when combined with the potential for higher income taxes on capital gains, may lead to an increased popularity of CRTs).

13. The Alternative Minimum Tax – The minimum income that sets off the A.M.T. is not indexed to inflation. Over the last decade, Congress has repeatedly passed a temporary “patch” so that tens of millions more taxpayers are not captured by it. If Congress does not act before Dec. 31, the A.M.T. will apply to some married couples earning as little as $45,000 and single taxpayers earning as little as $33,750

14. The expiration of the debt ceiling in or around February of 2013.

Other proposals that have been discussed or are under consideration:

1. Top income tax brackets to 35-39%.

2. Valuation discounts have been proposed for restriction or repeal numerous times. This may be another avenue of raising revenues on the wealthy.

3. President Obama has proposed a $3.5 million exemption.   However, the gift tax exemption is unsettled and may be only $1,000,000. The estate, gift and GST rate is scheduled to increase from the current 35% to 55%, but President Obama has proposed a 45% rate.

4. Restrictions to multi-generational dynasty trusts to 90 years.

5. Home mortgage interest deductions could be restricted.

6. Charitable contribution deductions may be restricted.

7. The state and local tax deduction for individuals has been talked about as a target.

8. The “Doc Fix” band aid that was not passed so far could lower Medicare reimbursements to physicians by 27%.

Wow, there is an amazing confluence of tax changes happening now. Will Congress get an act together (their act together)?  There is a lot of talk and speculation whether they will be able to agree on anything, but none of us want to go over the “fiscal cliff” as it will lead to serious economic consequences.

Many budget experts and economists are hoping for a two-part deal. The first part would extend many of the tax cuts and repeal the automatic spending cuts to avert the changes scheduled after Jan. 1. But it would be contingent on the second part: a framework for reducing projected long-term deficits by overhauling both the tax code – to raise revenues – and entitlement programs – chiefly Medicare and Medicaid, whose rising costs in an aging population are unsustainable.

It remains to be seen if we fall over the cliff or avert a disaster based upon the actions of our legislators.  It has been very difficult in estate planning for years because of the uncertainty.  I myself would like to have something decided and consistent.

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