Fiscal Cliff Negotiations: Our View Today

Important note:  This post is based on media reports from The Wall Street Journal and The New York Times, as of December 18, 2012. Fiscal cliff negotiations are very fluid, and until an actual deal is reached, and the fine print is released, a complete analysis is not possible.

The purpose of this post is to provide information and clarity, where possible, based on the information available as of this morning. It appears that concessions have been made by both sides, Democrats and Republicans, so basic concepts of a deal appear to be taking shape.

Tax rates: 

  • The White House has proposed permanently extending the Bush-era tax rates (current rates) on household income below $400,000. Above $400,000, they are proposing an increase from the current 35% to 39.6%.
    • While they are using a $400,000 figure, they probably mean “taxable income” of $400,000. So, after deductions, someone could actually earn well above $400,000, before the 39.6% marginal rate becomes effective.
  • For those with household or taxable incomes (to be clarified) of less than $400,000, it appears that there will be no increase from current federal income tax rates.
  • It is possible this $400,000 level will increase, as part of negotiations, but likely not to decrease.
  • As part of the health care reform passed in 2010, an additional Medicare tax of 3.8% will apply to unearned income (investment income, such as interest and dividends; capital gains and rental income), for married couples with income above $250,000. This is already law, and is not part of the current negotiations.
  • Also as part of the 2010 health care legislation,  income from self-employment and wages will be subject to an additional tax of 0.9%.  This applies to compensation of married couples in excess of $250,000 and single individuals in excess of $200,000 annually. 

Capital Gains and Dividend Tax Rates:

There has not been any published information on changes to the capital gains or dividend tax rates, or where these stand in the current negotiations. I would expect that the capital gains rate will increase from the current 15%, to 20% (plus the above 3.8% tax rate increase from the health care reform act). I cannot forecast what change, if any, there will be to the dividend tax rate, other than the known increase due to health care reform tax, discussed above.

Change in calculation of inflation:  There is a proposal to adopt a new method of calculating inflation, which is expected to result in showing less inflation. The impact would be to reduce the growth of certain benefits, such as inflation adjustments to Social Security. There are other impacts of this inflation calculation change, such as slowing the rate that tax brackets rise each year, so taxpayers would pay more Federal income tax each year, than if this change had not been made.  I have not seen any details on how the new inflation factor would be calculated, or whether this would affect the inflation factor that is used in the investment return for TIPS (Treasury Inflation Protected Securities). This change is subtle, but a very important provision.

AMT (Alternative Minimum Tax):  The White House is proposing to permanently extend the AMT inflation adjustment provisions, which Congress has done every year or two, for many years, as the original law did not include any inflation adjustments. This would provide needed clarity and correct a measure that Congress usually fixes anyway.

Payroll Tax Cut: The Wall Street Journal, but not the Times, reported that the White House did not request an extension of the Social Security payroll tax cut. This would represent a tax increase as of January 1, from 4.2% to 6.2% of the social security tax that all workers pay. This is a change in position for the Democrats, as it would directly affect workers of all income levels.

Deductions:

There were no reports of any changes to itemized deductions. It is possible there will be some type of cap or limitation on total itemized deductions, such as 28% or 35% of one’s adjusted gross income. It is possible that this change, if enacted, would only affect very high income levels.

Other items:

  • The White House is requesting upfront infrastructure spending, as well as a temporary extension of expiring unemployment benefits. Other tax breaks may be extended permanently, such as research and development credits for businesses. 
  • It is also expected that a permanent adjustment will be made to physicians’ Medicare reimbursements. This is to correct a 1997 law, that has been corrected on an annual basis, to prevent massive reimbursement reductions.
  • It is unclear whether there will be an increase in the age for Medicare eligibility, which is currently 65.  Republicans are proposing to increase this age to 67, to slow the growth of Medicare spending.
  • There are no details on specific spending cuts, or when the actual tax reform changes will be drafted. We would expect some tax changes to be approved in the near term, with further revisions in 2013.

Estate taxes:  There has been no public information about how estate taxes will change going forward, based on these negotiations.

If you would like to discuss any of these matters further, please contact our office.

    Sources:  The Wall Street Journal, http://online.wsj.com/article/SB10001424127887324407504578185362961624862.html?mod=WSJ_hpp_LEFTTopStories

    The New York Times, http://www.nytimes.com/2012/12/18/us/politics/president-delivers-a-new-offer-on-the-fiscal-crisis-to-boehner.html?hp&_r=0&pagewanted=print