Posts Tagged ‘fiscal cliff’

Fiscal Cliff Deal

Just as I predicted, taxes are going up.  While we were bringing in the New Year with our loved ones (or sleeping if you have little kids like me), the Senate agreed on a deal and the House passed it as well.  You may or may not know the details of the “fiscal cliff” deal by now.  Since it’s the New Year and I’d like to start it out on a positive note. I’ll try to approach the deal with the most optimistic tone as possible (though there is quite a bit to be pessimistic about in this deal). 

One thing I was glad to see was the permanent AMT patch.  Past legislation has only applied temporary patches to the AMT mess and made tax planning very difficult (2012 was no exception).  They finally made the “patch” permanent and indexed for inflation each year.  AMT still needs a serious overhaul, but this will help us in the mean time and saved over 60 million Americans from being subject to AMT (myself included!).  While I’m happy this patch is permanent, I’m concerned it means Congress won’t be as eager to redo or eliminate the AMT issue since it’s no longer urgent. 

Part of my prediction was correct on the income tax rates; rates for lower and middle income taxpayers were extended, however they were set permanently which I wasn’t expecting.  While I’m happy with the permanent nature because it helps with tax planning, it doesn’t mean Congress won’t change it again. The debt ceiling issue is again quickly approaching and tax rates may be thrown into the negotiations once again.  The other “positive” in the tax rates was the apparent compromise on the top tax rate level.  The President was proposing the 39.6% tax rate to be effective for income (based on adjusted gross income (AGI)) over $200,000/$250,000 (single/married).  The compromise ended up setting the 39.6% rate on taxable income (after deductions) of $400,000/$450,000 (single/married).  I see two positives in there.  While I disagree whole-heartedly with increasing taxes on the wealthy (a.k.a. usually the job creators), it’s a compromise that seemed inevitable and ended up better than I expected. 

While the income tax rates for the lower and middle income taxpayers are not going up, the payroll taxes did increase.  The 2% payroll tax holiday we’ve been enjoying was allowed to expire.  If you make $50,000 a year, you will bring home $1,000 less this year. 

The “wealthy” Americans will also be subject to the following tax increases (not inclusive):

  • Capital gains/ Dividend tax rates: from 15% to 23.8 %
  • Personal exemption phase out (previously eliminated), starts at $300,000 for married couples   ($250,000 single)
  • Limitation on itemized deductions (previously eliminated), starts at $300,000 for married couples ($250,000 single)
  • Estate taxes permanently increased from 35% to 40%, although they did set the exclusion at $5million (adjusted for inflation) which was set to expire back to $1million at 55% 1/1/13. 

The following items were set to expire, but have been extended (not inclusive):

  • Child tax credit of $1,000 was made permanent
  • Earned income credit was extended through 2017
  • Adoption credit/assistance was made permanent at $10,000
  • Child and dependent care credit was made permanent
  • Employer-provided child care credit was made permanent
  • American opportunity tax credit (higher education) was extended through 2017
  • Above-the-line deduction for qualifying tuition and expenses extended through 2013
  • Teachers’ classroom expense deduction extended through 2013
  • Exclusion of cancellation of indebtedness on principal residence extended through 2013 

Business related items in the deal include (not inclusive):

  • Section 179 deduction of $500,000 with a $2million investment limit for 2012 and 2013
  • Extended 50% bonus depreciation through 2013
  • Research tax credit was extended through 2013
  • Work Opportunity Tax Credit was extended through 2013
  • 100% exclusion for gain on sale of qualified small business (Sec. 1202) stock (see Paul Polito’s website article here)
  • A number of green energy tax incentives 

Not the perfect deal, but at least one was made.  We were saved from the “fiscal cliff” and now maybe we don’t have hear that term again… for the time being. 

Happy New Year everyone!

 

All $250,000 taxpayers may be the Wrong Target…Too important for such a broad brush.

All $250,000 taxpayers will often be the wrong target if the goal is to rebuild the economy with private sector jobs.

I have served small and medium sized private companies for over 35 years. The proposed tax increase on those so called “wealthiest Americans” is one of those broad brush solutions that will turn out to be counter-productive.

We know that employment is driven primarily by small to medium size privately held companies.  This makes sense.  These are usually owned by someone who lives in the U.S., works in the U.S. and does business primarily in the U.S.  Simply put, most small businesses exist to create a job for their owners and employees.  Contrast this “business purpose” with the purpose of a public company.  Public companies strive to build shareholder value.  Ever increasing pressure to create earnings tends to push labor intensive processes overseas and eliminate jobs through automation.

A study of most business classes will indicate that profit margin (net profit) generally runs between 5% and 10% if the business is profitable.  This category called “small to medium” size will have revenues somewhere between $2 million and $200 million.

Most of these businesses report their income and pay their taxes on the owner’s tax return.  Most of these business owners will tend to take salaries in the low 6 figures….say between $100,000 and $300,000.  Now let’s say that a typical “expanding” business grosses $5 million and nets 5%.  That net is $250,000.  When you add that to the say, $200,000 in salary, you are right in the cross hairs of the president’s proposed tax increase.  What may not be understood is that the $250,000 in profit is not in the owner’s hands.  It is in the business.  These earnings pay for things like new equipment, additional employees, debt principal and owner draws for taxes which are not deductible. 

In the accounting business, we call the $250,000 in my example “pass through” income.  The taxable income is passed to the shareholder’s or partner’s tax return, but the cash generally, is not.  When you tax it, the money has to come out of the company’s working capital leaving fewer dollars for expansion, hiring new employees, etc.

Also, when this “pass through” income is added to the owner’s salary, it is taxed at the owner’s highest rate which will be higher than the corporate rate if the President’s proposal is accepted by Congress.  It should not be taxed at a higher rate than the large corporations pay.  To do so will further cripple our economy.

An Individual who makes $200,000 per year in salary or a couple that makes $250,000 without adding any jobs to the economy probably ought to pay more tax.  But a business that employs people should not be subject to the same level of tax.  Fairness is not at issue here.  Our struggling economy is the issue!  There should probably be some sort of exemption or maximum rate of tax (like the current treatment of capital gains) for business pass through income that will help stimulate job growth in the economy.

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