On New Year's Day 2013, Congress finally reached a deal that kept America from hurtling over the dreaded fiscal cliff, which was touted as having the potential to plunge the United States back into a recession. However, the American Taxpayer Relief Act by no means provided complete relief for everyone. Approximately 77% of Americans will still see Uncle Sam take a larger bite out of their incomes. In fact, the Tax Policy Center stated that the new effective federal tax rate would average 21.7%, which is about 1.0 to 1.4% more per taxpayer. In dollars, this change translates into a whopping $1,257 annual average increase per taxpayer from 2012.
Impact on the Affluent
As expected, wealthy taxpayers were hit the hardest by the new legislation. The top tax rate has reverted from 35% under Bush to the 39.6% rate that it was under the Clinton administration. And taxpayers who earn at least $250,000 a year for singles and $300,000 a year for couples will also see a more aggressive phaseout schedule for both personal exemptions (the amount that can be automatically deducted for each person that is listed or claimed as a dependent on the tax return) and itemized deductions (such as charitable contributions, mortgage interest and property taxes).
The long-term capital gains tax rate will increase from 15% to 20% for those in the top bracket, and "qualified" dividends will no longer be eligible for long-term capital gains treatment. Finally, a law passed in 2010 will take effect. It levies an additional 3.8% tax on investment income above $250,000 for couples and $200,000 for singles.
The Other 99%
Although the top one percent of taxpayers will feel by far the most impact from the new legislation, rank and file Americans will see an immediate difference in their paychecks as well. The moratorium on the full Social Security withholding rate has come to an end, and employers must now begin withholding the standard 6.2% from each employee's paycheck instead of the 4.2% that Obama allowed for the past two years as a measure to combat the recession. For someone who was earning about $50,000 in 2012, this change amounts to about $1,000 less in take-home pay per year. Furthermore, households with an adjusted gross income (AGI) between $40,000 and $50,000 will pay additional average taxes of $579 per year and households in the $50,000 to $75,000 range will have to fork over an average of $822 more in 2013.
Some Good News
Taxpayers will be glad to know that Congress was able to adequately raise the threshold for the dreaded alternative minimum tax (AMT) so that it will not affect most Americans. Congress also permanently indexed three of the main factors that trigger this tax. The estate tax laws also remain largely unchanged, and taxpayers can now leave $5 million of assets to heirs without taxation, although the rate for taxation above this amount was raised from 35% to 40%. These exemptions will also be permanently indexed for inflation.
The charitable contributions deduction for IRA charitable donations has also been made permanent, allowing taxpayers to donate their otherwise taxable distributions from traditional IRAs directly to charity without having to declare them as income. Wealthy taxpayers will also be happy to learn that several sophisticated types of trusts, such as dynasty and defective grantor trusts, have also been granted amnesty under the new law.
The Bottom Line
The new tax laws will affect different people in different ways, but the increase in Social Security withholding applies to everyone who earns income from an employer. To get a clear idea of how the changes affect you, use the Tax Policy Center's calculator, or consult your tax or financial advisor.