More Than Meets the Eye


While our TaxTrends posts are typically light and, we hope, entertaining, sometimes it can be hard to find the humor in something that is very serious to all taxpayers: the bottom line. We know you'd probably rather read about Santa Clause and his business deductions than the latest and less than greatest changes to our tax obligations, but it’s essential that we all understand the American Taxpayer Relief Act of 2012 and what it means for your tax return.  

The basic tenets of the last-minute deal to avoid a "fiscal cliff" disaster have been widely reported. The deal extended the Bush tax cuts, permanently, for incomes up to $400,000 for single filers and $450,000 for joint filers. Ordinary income above those thresholds will be taxed at 39.6%; corporate dividends and long-term capital gains will be taxed at 20%. And, blessedly, the Alternative Minimum Tax is "patched" for good, and the estate tax is eliminated for estates under $5 million.

For the vast majority of taxpayers, this is good news, because so few of us meet the threshold for triggering those higher taxes. So if your income isn't that high, you’ve dodged a major bullet. But there are also provisions in the deal that affect all taxpayers and the reality is, you probably will be paying more tax, even if your income is nowhere near $400,000.

The fiscal cliff legislation includes the following:

  • Provisions phasing out personalized exemptions and itemized deductions for singles earning over $250,000 and joint filers earning over $300,000. If you are in this group, you'll lose 2% of your personal exemptions for every $2,500 over the threshold. And you'll lose $3 of your itemized deductions, up to 80% of the total, for every $100 of income above the thresholds.
  • The 2% payroll tax "holiday" that every taxpayer enjoyed in 2011 and 2012 is over, and won't be coming back.
  • Finally, the new Medicare tax provisions of the Affordable Care Act take effect. Medicare taxes on earned income go from 2.9% to 3.8% on incomes above $200,000 ($250,000 for joint filers). And there's a new "unearned income Medicare contribution" on "Investment income" (interest, dividends, capital gains, rents, royalties, and annuities) for those same thresholds.

So the truth is, while the legislation mostly focused on income over $400,000, there are some issues that may affect taxpayers below that threshold. Fortunately (or unfortunately, depending on how you look at it), the median household income in the United States is $52,762 - well below either threshold!

And even better news - the fiscal cliff legislation extends all sorts of tax breaks that were in danger of expiring. These include expanded first-year expensing and bonus depreciation deductions for business equipment, tax-free charitable gifts from IRA accounts, expanded student loan interest, and even the above-the-line deduction for educator expenses.

There’s bound to be further discussion about the legislation, not only because the tax provisions of the fiscal cliff legislation run over 80 pages, but because there are more battles to come regarding our nation’s debt and economy. During all of this, it’s more important than ever to make sure your taxes are in compliance to avoid IRS scrutiny. It’s not hard to understand why when there are uncertain economic times, IRS enforcement moves full speed ahead!