At the eleventh hour on New Year’s Eve, Washington negotiators reached a compromise to avoid the “fiscal cliff” – the looming combination of tax increases and spending cuts that threatened to throw the country back into recession.
One of the most important parts of that compromise has often been overlooked. The compromise made permanent changes to the tax code. For over the past decade, when Congress changed the tax law, it typically included a “sunset” date, when the changes would expire and the prior law would again take effect. These sunset dates made planning difficult, because taxpayers never knew if Congress in fact would allow a law to expire or instead would enact another temporary extension.
Now, for the first time in over a decade, changes to the tax law have been made permanent. Of course, Congress can still change the tax law in the future, but at least the changes do not have built-in expiration dates raising concerns about the new law expiring.
The fiscal cliff compromise made the following changes to income tax rates for 2013 and beyond:
Taken together, these changes create four sets of tax rates on investment income where before there was one:
|Family income||Ordinary income tax rate1||Cap gain / Dividend tax rate|
|< $250K||35% max||15% max|
|$250K – $300K||38.8%||18.8%|
|$300K – $450K||39.8%||19.8%|
|(Bush tax cuts expire)|
The fiscal cliff compromise makes other tax changes as well:
At the same time, there were a number of things the compromise did not do:
1 “Ordinary income” is income that is taxed at an unreduced rate. Types of investment income taxed as ordinary income include interest (other than tax exempt interest), rents, and royalties. Dividends, capital gains, and tax exempt interest are not ordinary income as they are taxed at lower rates (or not at all).
Compensation income (income from a job) also is “ordinary income” because it is taxed at an unreduced rate. The 3.8% does not apply to compensation income. Instead, compensation income is subject to a new 0.9% surtax. The chart addresses only the taxation of investment income.
Andrew H. Friedman is the Principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. He may be reached at www.TheWashingtonUpdate.com.
Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
Copyright Andrew H. Friedman 2013. Reprinted by permission. All rights reserved.
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