The American Taxpayer Relief Act?

One wonders if the comedian turned senator, Al Franken, came up with the name for the “cliff hanger” tax bill passed January 1, 2013. Taxpayer relief?  A laughable assertion. Yes, the bill averted a bigger tax increase, but those who work and the more affluent will see their share of the “fair share” rise.

Paychecks are shrinking. In 2012, Social Security taxes took 4.2% of a worker’s paycheck up to a ceiling of $110,100. Now the ceiling is $113,700 and the rate, 6.2%. Workers will have withholding rise by 2%. One who meets the maximum will pay $2429.30 more this year, $101.22 of reduced pay over 24 bi-monthly paychecks. For most workers above the poverty level, this reduction will reduce savings or spending rates perhaps marginally, if at all.

The brunt of the tax increase is borne by couples with adjusted gross income (AGI) over $450,000 and singles over $400,000. (How’s that for a marriage penalty?) The top marginal rate rises to 39.6% versus 35%. This hits successful privately held businesses taxed at personal rates, and will be a drag on employment, although the effect is difficult to quantify.

The tax-grabbing clowns slipped in a zinger that impacts those making $250,000 single and $300,000 joint AGI. The personal exemption and itemized deduction phase-outs eliminated in 2010 are restored, increasing potential tax liabilities for those with large deductions for things like mortgage interest, medical bills, or charitable giving. Regarding charities, taxpayers 70 ½ or older may donate up to $100,000 of IRA assets directly to a charity and have it count as part of the required minimum distribution. One cannot deduct the donation as a gift but it does not count as income, perhaps saving taxes elsewhere.

The good news for investors is that dividends and capital gains are treated equally, and taxed at a lower rate than interest. For those over the $400,000 single and $450,000 joint thresholds, the long-term capital gains rate goes to 20% versus 15%. For the bulk of retired folks whose AGI is less than $400K to $450K, the maximum rate stays at 15%.

Separate from the 2013 tax bill, a host of taxes kick in under the 2010 Affordable Care Act (another hilarious moniker, as medical care costs rise). IRC Section 1411 adds a 3.8% Medicare surtax on net investment income, which includes capital gains, an overall rate 23.8%  for higher-income taxpayers—a  58% increase from 2012 rates!

However, even for those subject to the Medicare surtax, tax-wise long-term gains and dividends are preferable to ordinary income. To quote William Ferer at Reaves Asset Management in New Jersey: “While marginally less so than before, the basic premise of  investing long term in solidly growing equities which raise their cash dividends over time continues to resonate as an enduring strategy.”

The estate and gift tax exemption remains at $5,120,000 with an annual inflation adjustment. With proper planning, a couple could pass over $10 million to heirs estate tax free. This is good news for many farmers and closely-held business owners. A number of tax reduction strategies remain in place for those of higher net worth.

Life insurance placed in an Irrevocable Life Insurance Trust, especially “second to die” coverage, remains as a way to transfer significant discounted and tax-free dollars to heirs and charities.

The annual gift tax exclusion increases to $14,000 for 2013 ($28,000 for a joint gift). This is of interest to parents and grandparents funding 529 College Savings Plans.

After all the drama over “the fiscal cliff,” we end up with a tax jolt and no reduction in the deficit. The non-partisan Congressional Budget Office (CBO) indicates that after nailing certain investors, higher earning individuals, job-producing successful business owners, and workers, the legislation will add $4.0 trillion to the current deficit numbers over the next 10 years. And that, friends, is NOT funny! The tragicomedy continues!

Lewis Walker is President of Walker Capital Management LLC and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA).  Lewis Walker and Mike Hostetler are registered representatives of SFA which otherwise is unaffiliated with the Walker Capital Companies.