All Things Financial Planning Blog

Paragliding Off the Fiscal Cliff


Asset-Allocation-in-a-CrisiWell the fiscal cliff, much like the Mayan calendar, and much like Y2K, was just another non-event. A lot of buzz with even a lot more fizzle. The sun has risen, aircraft are safely landing and football dominates the thinking of sports minded folks as we all enjoy the first day of the New Year and the rest of our, hopefully long, lives! Not to downplay the significance of what could have happened had all things remained unsettled and all provisions of previous tax and budget agreements been exercised, just a comment on how often we hear that the World is coming to an end only to find that through all the huffing and puffing nobody’s house was blown down.

Soon we will learn more about the specifics of the 11th hour agreement and we will then hear lengthy discussions from the media and others about how ‘the can just got kicked down the road’! Yes, there are components of the bill that will be ‘permanent*’ but there will still be budget deficit ceiling negotiations, tax reform* discussions and entitlement reform to deal with in the next two months before we can say we have our fiscal house in order, whatever that may look like, remembering that there are differences in opinions about balanced budget management requirements versus budget deficit flexibility, etc., etc. etc.

The Tax Policy Center has estimated, as a result of the Taxpayer Relief Act of 2012, an average annual ‘pocketbook’ hit depending on the following levels of taxpayer income …

$20,000 to $30,000 $297
$30,000 to $40,000 $445
$40,000 to $50,000 $579
$50,000 to $75,000 $822
$75,000 to $100,000 $1,206
$100,000 to $200,000 $1,784
$200,000 to $500,000 $2,711
$500,000 to $1,000,000 $170,341

[Chart courtesy of LA Times, author Alana Semuels]

Taxes on Earnings
Payroll. Everyone will feel the loss of the 2% payroll tax holiday starting January 1, 2013. If you make more than $200,000 (single) or $250,000 (married filing jointly) you will also feel the PPACA (Obamacare) 0.9% additional ‘health care’ tax taken from your paycheck.

‘Ordinary Income’
Wages and interest income (as well as short term capital gains) will be taxed at the ordinary tax rate brackets which will remain the same as prior years (Bush tax cuts) except for individual taxpayers earning over $400,000 or married taxpayers earning over $450,000. Those taxpayers will see their tax rates go as high as 39.6%. For individuals earning more than $200,000 and married couples earning more than $250,000 there will be a 3.8% ‘health care’ tax added to the taxes paid at ordinary rates for interest income earned (and short term gains but not for wages).

‘Capital Gains and Dividends’
The good news here is that capital gains (long term) and dividends will both still get favorable capital gains tax rate treatment of 0% or 15% if your income is under the $400,000/$450,000 level. If your income is over those amounts, a capital gain maximum rate of 20% will apply. Let’s not forget, however, that the 3.8% ‘health care’ tax ($200,000/$250,000 income levels) comes into play here as well making the potential capital gains rate for those making more than the $400,000/$450,000 a maximum 23.8%.

Alternative Minimum Income Tax (AMT)
This is a break, if you can call anything about AMT a break. For each of the past several years tax preparers have had to wait until the last minute for Congress to come up with a statutory AMT exemption amount (it is like our standard deduction that we have for regular tax purposes) so that we would know who would or would not become subject to AMT. If Congress had not upped the 2012 exemption amount to $78,750 for married couples and $50,600 for individuals, a married taxpayer could have had to pay, perhaps, as much as $8,775 more in taxes in 2012 [$78,750 – $45,000)(.26)].

Itemized Deductions and Personal Exemptions
A couple of years ago there was an income phaseout employed to reduce the benefit a higher income earning taxpayer would get from itemized deductions and personal exemptions. That phaseout for itemized deductions is being brought back for 2013 and will start at $250,000 for individuals, $275,000 for head of household and $300,000 for married filing jointly. Personal exemptions will have the same phaseout dollar filing status threshold amounts, again, for tax years 2013 and thereafter.

Extended through 2013

  • Tax free distributions from IRA to charity
  • Educator expenses
  • State and local sales tax deduction
  • Debt relief income recognition exemption for qualified residence indebtedness
  • Variety of energy tax credits for energy efficient homes and energy-efficient appliances.

Extended for five years

  • Enhanced earned income credit
  • American opportunities credit

Extended permanently

  • Child tax credit of $1,000

Estate tax

  • Estates that exceed $5,000,000 will see the estate tax rate increase to 40%
  • Annual gift tax exclusion amount is $14,000 per individual for 2013

Again, the good news is that we didn’t end up like Thelma or Louise and we didn’t experience the thrill of a bungee-cliff-dive, both very good things. The bad news is that we seriously need to bring all sides together to address long term fiscal soundness through tax, entitlement and budget reform. All in all this Taxpayer Relief Act of 2012 is very modest in tax law changes and tax savings so a lot of work will need to be done in the next two months. Let us hope that this year’s group of elected officials can get the job done! Happy New Year to All!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA

Author: David Bergmann, CFP®

ACADEMIA David has been an instructor in UCLA’s CFP Board Accredited Personal Financial Planning Certificate Program since 1995 and he is a member of the Program’s Academic Review Committee. David has taught both the Financial Analysis and Employee Benefits/Retirement Plan courses and regularly teaches the Federal Income Taxation in PFP class. He is also the instructor for the Ethics course and oversees the internship program. PROFESSIONAL CONTRIBUTIONS David has served as an editorial reviewer for the Journal of Financial Planning since the magazines inception. He has been a reviewer for the FPA’s Financial Planning Perspectives publications and other various National publications. David served from 1988 through 1990 as President of the Los Angeles Society of the Institute of Certified Financial Planners (ICFP). He also served on the National Board of the ICFP from 1988 through 1993 having chaired The Education, The Communications, The Regional Directors and The Case Law Oversight Committees as well as serving a year on the Executive Committee. David has been a mentor and since 2006 has been a Dean in the nationally recognized FPA’s Residency Program. PROFESSIONAL ACTIVITIES The David R. Bergmann Group is a comprehensive services firm supporting the work the firm does in, and with the process of, comprehensive Life Financial Planning. In our life financial planning process we focus on the client’s life goals and individual passions in the context of what brings joy, purpose, fulfillment and sense of valued legacy and then we structure their financial affairs and personal resources to enable, inspire and empower them to live their impassioned and fulfilled life. David was twice named as one of the Top 100 Financial Advisors in the country by Mutual Fund Magazine. He has appeared on CBS Nightly News and in many National print publications, including the Wall Street Journal, Investor’s Business Daily, Business Week, and others.

2 thoughts on “Paragliding Off the Fiscal Cliff

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