Recently, Congress passed a fiscal cliff deal – at least a tax portion of the deal. While the spending portion of the fiscal cliff will be up for debate in February at the same time there is likely to be a battle over the debt ceiling, a tax deal has been reached.
Chances are that you will be affected by the fiscal cliff deal, so here are 7 things you should know about the compromise:
1. The Payroll Tax Cut Was Allowed to Expire
You may not realize it, but you have been enjoying a 2% payroll tax cut for the last couple of years. The fiscal cliff deal didn’t extend the tax cut, so that means that you will have a smaller paycheck, since the payroll taxes are back to normal.
2. High Income = $450,000 for Married Couples
Congress decided that “high earners” for the purpose of raising taxes was at $450,000 for married couples, and $400,000 for those filing as single. The tax rate went up only for those in this income group, rising to 39.5%. If you fall into this category, you will see higher taxes. It’s also worth noting that other tax brackets are now indexed to inflation.
3. AMT Indexed to Inflation
One of the biggest problems with the Alternative Minimum Tax was that it continually needed a “patch” in order to keep it from hitting those in the middle class. Congress finally did something permanent about the problem, and indexed the AMT to inflation, so a regular patch is no longer needed.
4. Education Tax Breaks Have Been Extended
The fiscal cliff deal extended some of the education tax breaks that have been up for changes. The American Opportunity Tax Credit, instead of dropping to $1,900 for two years, remains at $2,500 for up to four years – at least until 2017. It’s also still possible to take up to $4,000 a year in deductions for tuition and fees (although you can’t take the deductions and the American Opportunity Tax Credit at the same time).
5. Student Loan Interest Deduction Becomes Permanent
If you have a student loan, you can deduct the interest you pay on it permanently. It used to be that you could only deduct your loan interest for the first five years of your loan repayment. Now, though, you can deduct your student loan interest (subject to income phase outs) for the entire life of the loan.
6. Permanent Estate Tax
The estate tax was made permanent with the fiscal cliff deal. However, the exemption is $5.12 million per person (indexed to inflation). So, if your estate is worth more than $5.12 million ($10.24 million if you’re married), you will need to realize that your heirs will see a reduction in their inheritance due to the estate tax.
7. Capital Gains Rise to 20% for Higher Earners
The long-term capital gains tax has risen to 20% for those who are high income earners under the fiscal cliff definition. For high earners, though, it still means that long-term investments are still desirable, since gains are taxed at a lower rate than their marginal rates.