February 2013

The Fiscal Cliff and You

Author: David H. Shatz

The drama behind the Fiscal Cliff turned out to mimic a reality show or soap opera more than politics. There were legitimate and material issues facing virtually every American taxpayer. It made for long and frequent articles, monologues on the evening talk shows, rhetoric and points of views from both sides of the political spectrum that seemed to circle around and around, like a broken record, until the legislative and executive parties could get maybe not onto the same page, but at least into the same book. In the end exactly what happened was predictable: action on what had to be acted upon now, with minimal concessions, compromise and change, and tabling the rest to the future. This, on a short-term basis, pleased most of the middle and lower classes. It also pleased those late night talk show hosts and, of course, the lobbyist.

The single item that affected more people than any other was the expiring Social Security payroll tax deduction, a.k.a. FICA. If you are an employee, by the time you are reading this article you are already feeling it. Two years ago, the government temporarily lowered the FICA tax by 2 percent, specifically stating this was for only two years. On January first of this year, that benefit expired and returned back to the level it’s been since 1990 (though it began in 1937). In real dollars, an employee earning $30,000 annually loses $600/year, $50/month. This wasn’t actually part of the Fiscal Cliff because it was already set to go back to its previous level. Government could have extended this, but that would have meant less tax dollars for the government, counterproductive to its goals. This was the only real bite taken from the lower and middle classes.

One of the biggest issues, in terms of time spent debating, was raising the tax rate on the wealthiest top 1 or 2 percent (taxable income over $400,000). And the resulting change wasn’t that drastic, with the top rate going from 36 percent to 39.6 percent, just returning back to the level before the Bush-era tax breaks began. An additional cost for these taxpayers, itemized deductions and exemptions can be reduced and/or limited, effectively increasing their total tax expense.

FYI, the top tax bracket in both 1965 and 1975 was 70 percent (on income over $200k), early ’80’s 50 percent (over $106k), and now for 2013 39.6 percent (over $400k).

The other big issue was long-term capital gains (LTCG) tax rates. With the Bush-era tax breaks came a lower tax on LTCG (the income derived from profits when selling assets/investments such as stocks, bonds, real estate, collectibles, business assets, etc.) held for at least one year. Since the Bush tax breaks, no matter how wealthy, LTCG rate was topped at 15 percent, reduced from 28 percent. Remembering back to the campaign trail, this is the reason Mitt Romney pays a lower rate than the average middle class employee (the bulk of his income is considered LTCG.) The year-end compromise raises this rate to 20 percent, but again, for only the wealthiest top 1 or 2 percent. Also, the top will have to pay additional Medicare taxes on this income, creating an effective LTCG rate of 23.8 percent.

Pertaining to estate taxes, for those who have a net worth of less than $5.12 million ($10.24 million for married couples), estate (death) taxes do not affect you. For those over this amount, the estate tax rates went up. See a good estate attorney. You can afford it.

Some key tax credits that could have gone away but didn’t were credits for college education, child tax credit (up to $1,000 per child), child and dependent care credit (daycare, after school care, summer day camp, etc.), and deductions for sales taxes paid (most relevant to those in the seven states without state income taxes), and business “Bonus” depreciation (ability to write off furniture and equipment immediately instead of over several years.)

Much talk was on the issue of the Alternative Minimum Tax (AMT) patch. In layman’s terms, there is a second and separate formula to calculate federal income tax, created so the very wealthy couldn’t take excessive deductions to create a low or zero tax. Over the years, this formula has evolved and crept down into the middle class, causing higher effective tax rates for the middle class. That’s not the purpose for which the AMT was created. If Congress didn’t patch this now, way too many (30-60 million) middle class taxpayers would have been affected for 2012 and thereafter. Also, this would have created a panic in the IRS as forms and software would have had to be changed, possibly creating the need to extend April 15. The government was not going to let that much-needed cash flow be delayed. Bottom line, neither party wanted this middle class burden.

Speaking of bottom lines, here’s mine. Our government missed a rare opportunity to:
Finally modify our overly complicated and unjust tax code;
Fix loopholes and squash special interest advantages;
Examine reducing costs associated with Medicare, Medicaid and Social Security;
Make substantial strides towards deficit reduction, including a mandate for a balanced budget;
And work towards a realistic long-term plan to reduce the national debt and strengthen our credit reputation around the world.

Instead, this Band-Aid to the Fiscal Cliff solved little, postponed acting on spending cuts to a later date and introduced temporary fixes to several issues that will again, shortly, need to be debated and remedied. This proves once again that our politicians are no different from my 12-year-old daughters, procrastinating until the last possible minute to finish their science and English projects that they knew about since the beginning of the school year.

David H. Shatz Tax and Business Center offers tax preparation services for individuals and businesses as well as bookkeeping, payroll and consulting services. Offices are located at 2 Corpus Christie Place on Hilton Head Island and at 181 Bluffton Rd., Magnolia Village, Unit A-104 in Bluffton. To learn more visit our website at davidshatz.com or call (843) 290-8080.

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