Fiscal Cliff Deal Creates Changes to Tax System

Federal Tax Policy with Fiscal Cliff Updates
Federal tax code has not substantially changed for over two decades. 2013 brings a new set of rules and guidelines for all U.S. tax payers. Keep in mind that filing for 2013, is not due until April 2014. Individuals, families and businesses across the board (not only higher-income individuals or households) will be impacted, to some degree, by federal tax rate changes negotiated through the fiscal cliff deal. For an overview of the changes the fiscal cliff deal will bring, see below.

Capital Gains/Carried Interest
The capital gains/carried interest rate will increase from 15 percent to 20 percent for individuals with and adjusted gross income (AGI) more than $400,000 and married couples with AGI more than $450,000. Individuals/couples below the $400,000/$450,000 AGI level will still pay 15 percent.

3.8 Percent Healthcare Tax
Passed under the Affordable Care Act in 2010, the 3.8 percent healthcare tax will affect some real estate transactions. Individuals with AGI more than $200,000 and married couples with AGI more than $250,000 may be subject to the 3.8 percent healthcare tax.

Payroll Tax
In February last year, the payroll tax cut was extended until Dec. 31, 2012. Payroll tax includes Social Security payments that were cut to 4.2 percent instead of 6.2 percent. Without language in the fiscal cliff deal, the payroll tax reverted back to the pre-recession level of 6.2 percent. It is estimated that the average worker will pay about $1,000 more in taxes annually, or about $42 per pay check.

Alternative Minimum Tax
Under the fiscal cliff deal, the AMT received a permanent fix and will adjust for inflation. The AMT will be less burdensome on lower-income levels with more exemptions for credits or tax deductions whereas higher-income levels will receive less exemption opportunities.

Exemptions and Deductions
Individuals with AGI more than $250,000 and couples with AGI more than $300,000 should expect a phase out of the personal exemption of $3,800 and itemized deduction write-offs. Direction on the "Pease" provision was included in the fiscal deal ("Pease" is named after Congressman Don Pease (OH) who created an itemized deduction phase out in 1990). The itemized deduction phase out was avoided with the recession and Bush-era tax cuts. As clarified by the fiscal deal, the "Pease" provision will now eliminate up to 80 percent of deductibles for $300,000 AGI couples or $250,000 AGI individuals: including charitable donations and mortgage interest.

Estate and Gift Tax
Estate or gift taxes will be taxed at or above the $5 million (per person) level but the tax rate will increase from 35 percent to 40 percent in 2013.

Depreciation ("bonus")
Businesses may deduct up to 50 percent of expenses (property and equipment), not including real estate for the 2013 tax year.

Leasehold Improvements
There is a 15-year straight-line cost recovery for qualified leasehold improvements on commercial properties that extends through 2013 and is retroactive for 2012.

Income Tax Rates
The greatest change will be for individuals with AGI over $400,000 and married couples with AGI over $450,000; a new tax rate of 39.6 percent applies to this income level. For incomes below, the Bush-era tax rates became permanent.

On January 3, 2013 the Internal Revenue Service released a guide on new federal tax rates, Updated Withholding Guidance for 2013. Read more.

The fiscal cliff negotiations did not produce changes to federal tax policies on depreciation recapture or passive loss.

IREM legislative staff will monitor these developments and report back to members if necessary.