Happy New Year! The Cliff was Averted

Amid intense political drama, Congress passed the American Taxpayer Relief Act on New Year’s Day to avert massive tax increases for nearly all earners that were slated for January 1st. The best comment I’ve read thus far on the legislation comes from David Lifson, an accountant at Crowe Horwath in New York. He says that the new law “replaces uncertainty with confusion.” Lifson goes on to say that, “Only tax wizards can understand the entirety, especially for people earning between $200,000 and $450,000.”

In fact, the American Taxpayer Relief Act is not as simple as it’s been billed. Yes, the top 1% of taxpayers will bear the biggest burden when the 35% bracket increases to 39.6% for individuals with at least $400,000 of taxable income or couples with at least $450,000. However, many other families will pay more, too. For instance, the most immediate change affects nearly all workers: Congress allowed a two-percentage-point cut for the employee portion of the Social Security tax to expire.

Another major change is with the personal exemption, the amount of money a taxpayer can deduct for him or herself and dependents. In 2013, this exemption is expected to be $3,900, so a couple with three children could deduct $19,500. However, this year the exemption will phase out for people starting at the $250,000/$300,000 income thresholds, and disappear completely for couples with $422,500 of adjusted gross income. So, a couple with three children and adjusted gross income of more than $300,000 will lose some or all of their $19,500 exemption.

Another curve ball is the Pease provision, named after former Rep. Donald Pease (D-Ohio) which could significantly limit charitable donations and mortgage interest for taxpayers above the $250,000/$300,000 taxable income thresholds.

And, there’s plenty more to digest and keep us busy planning as we wait for the Internal Revenue Service to release the new inflation-adjusted tax brackets for 2013…