President Signs Fiscal Cliff Agreement
The President and Congress reached a bipartisan compromise late into the night on New Year’s Day to avert year-end tax hikes and spending cuts referred to as the “fiscal cliff.”
The American Tax Relief Act of 2012 puts in place a series of measures to prevent the most pressing effects of the “fiscal cliff,” including middle class tax increases, as well as immediate, across- the- board spending cuts to domestic and defense programs, also known as sequestration, which have now been delayed for two months. However, the measure does not address raising the debt ceiling, completing work on the federal government’s fiscal year 2013 budget or long-term deficit reduction through tax reform, entitlement reform or some combination. Congress and the President will need to address these matters in the next two to three months; before the debt ceiling is reached, across- the- board spending cuts are triggered, and the resolution to keep the government running expires.
Importantly, the current measure does not change the exemption on municipal bond interest, a priority for the GFOA and other organizations representing states and local governments. However, limiting or eliminating the exemption entirely may still gain traction during debate on more comprehensive tax reform in 2013.
The American Tax Relief Act of 2012 makes the following significant changes:
Social Security payroll tax - The temporary 2 percentage- point- cut in the Social Security payroll tax expires under the negotiated compromise. Social Security is financed by a 12.4 percent tax on wages up to $113,700, with employers paying half and employees paying the other half. The 2010 stimulus measure had reduced the share paid by employees from 6.2 percent to 4.2 percent, saving an average family about $1,000 a year.
State and local sales tax deduction - The bill would extend the deduction for state and local sales taxes in lieu of state income taxes.
Bond Provisions - The following bond provisions that were in place in 2012, and in some instances years prior to that, have been extended through 2013. These include: $15 million arbitrage exclusion for school construction bonds; authority to issue qualified zone academy bonds; tax-exempt private activity bonds for qualified school construction; and Liberty Zone bond authority.
Transit Benefit – The new law raises through 2013 the employer provided pre-tax deduction for transit benefits to $240 per month up from $125 and equal to the employer provided parking benefit also of $240 per month.
Income and investment taxes - The new tax package would increase the income tax rate from 35 percent to 39.6 percent on income above $400,000 for individuals and $450,000 for married couples. Investment taxes would increase for people who fall in the new top tax bracket, including a 20 percent rate on capital gains and dividends, up from the current 15 percent. Those increases will be in addition to the 3.8 percent tax on investment income starting this year under the 2010 health-care reform law for individuals earning more than $200,000 a year and couples earning more than $250,000.
Exemptions and deductions - Individuals earning $250,000 and couples earning $300,000 or more will face limits on their personal exemptions and itemized deductions because the phase outs and limitations on these items, commonly known as the Personal Exemption PhaseOut (PEP) and the Pease limitation, used in the 1990s, were reinstated as part of the negotiations.
AMT - The measure permanently indexes the Alternative Minimum Tax for inflation.
Estate Tax – The new law raises the estate tax from its current rate of 35 percent to 40 percent, with the first $5 million in assets exempt.
Unemployment benefits - The bill extends emergency unemployment benefits for one year, preventing nearly 2 million Americans without jobs from losing their benefits beginning 2013.
Doc Fix - The bill would put off for one year the scheduled 27 percent cut in physician reimbursement payments under Medicare.
Energy Incentives – The new law extends for one year a host of energy and other business incentives.
Farm bill extension – The farm bill will be extended through fiscal year 2013 to avert, in particular, a spike in milk prices.
Congressional pay freeze – The pay freeze on members of Congress will continue indefinitely.