Well, the dramatic conclusion to the political and Federal budgetary showdown known as the “Fiscal Cliff” has come to a head: the Senate deal constructed on New Year’s Eve has been passed by the U.S. House of Representatives. Surprisingly, the bill garnered much of its support in the Chamber from high-profile Republicans like House Speaker John Boehner (Ohio) and former Vice Presidential hopeful Paul Ryan (Wisconsin). Not surprisingly, it does nothing to address the nation’s most threatening crisises, most notably the looming debt ceiling threshold we’re likely to cross as early as February 2013.
So what exactly does the bill accomplish? And more specifically, how does it affect small business owners? That will be the focus of this week’s Blatt Watch, the first of three installments that I’ll cover regarding this landmark legislation.
The first thing to note is that “sequestration”, or the painful round of automatic across-the-board spending cuts set to take place on January 1st, 2013, have been delayed for at least two months. The deal doesn’t touch those cuts, aside from protecting long-term unemployment benefits. Federal income tax codes as they affect small businesses, however, are another story.
Payroll Tax Increases in Plain English
The most significant and immediate impact you as a small business owner (and your employees) will face is a slight, albeit effectual, increase in payroll taxes (Social Security and Medicare tax withholding). This increase is the result of the expiration of the payroll tax cuts that took the FICA rate down two percentage points, a move that economics suggest would boost consumer spending; the rate will now revert back to 6.2%, sapping an estimated $20 a week from your and your employee’s paychecks. The tax credit is expiring for all waged employees regardless of personal income tax rates.
Income Rates Rise for Highest Earners
In addition, ordinary income above $400,000 a year ($450,000 for married joint filers) will be subject to a tax increase of about 4.6% to a maximum top rate of 39.6%. Only the income above this level is taxed at this rate. Tax rates for incomes below this threshold will remain the same, ensuring about 98% of the American population and 97% of businesses owners will see no increase in their tax liability (aside from the payroll tax increases described above). Corporate tax rates will remain in effect as they are now.
Capital Gains on Investment Income and Dividends Rise to 20% for Those Highest Earners
For individuals and couples filing at the income levels described above, you’ll see an increase in the rates taxed on long-term capital gains and investment income from 15% (rates set in place by the Bush Tax Cuts of the early decade) to more normalized rates of 20%. The deal did nothing to address or alter the Obamacare tax of 3.8% on the lesser of either net investment income or the adjusted gross income (AGI) for single filers earning more than $200,000 from their investments ($250,000 for married joint filers).
Alternative Minimum Tax (AMT) Patch is Permanent
The AMT patch that pegs the minimum income threshold to account for inflation, a measure that until yesterday required yearly Congressional “approval” has been permanently ratified. Going forward, the AMT exemption has been raised to $50,600 for single filers ($78,750 for married joint filers) and will adjust with inflation to help unsuspecting middle-income earners fall into the unpopular tax bracket due to regular incremental wage increases.
Higher income earners (those in the $400,000 range, for example) are the group that’s likely to be most affected by the AMT fix since the Bush Tax Cuts have effectively been phased out for the highest-earning individuals and couples. Itemized income tax deductions for things like mortgage interest are capped beyond these income levels, forcing the election of the AMT.
Popular R&D Tax Credit Extended
The Research and Experimentation Tax Credit, first adopted in the early 80’s mostly as a nod towards early information age tech giants like Intel, has been extended through 2013. The intention of the provision is to encourage investment and research performed on behalf of small business within our borders. It allows companies to deduct expenses relating to “qualified research” conducted in the States, a relatively flexible term, including wages, contract research, and start-up costs, and allows the deductions to be realized immediately or carried forward for up to twenty years.
And if you didn’t think your business was eligible, think again. Here’s a great article by Dean Zerbe for the Washington Post that explains why so many small to medium-sized businesses don’t pursue the tax credits due to “self-censoring” – or a misguided belied that their business won’t qualify – and why you should take a look at it with your accountant. The federal guidelines for what qualified research encompasses has been and continues to be broadened. Food distributors, shipping companies, and even software distributors can take advantage of the credit, which could reduce taxable corporate income by as much as $70,000 or more.
I’m happy to see investors and traders react favorably to the deal in the markets today. At last check, the DOW was up over 235 points, with the NASDAQ and S&P 500 both logging gains of 27 and 75 points respectively, for gains in the 2-2.5% range for the day. I expect to see the rally continue for some weeks to come, and for January 2013 to be a good month for stockholders.
Come February 2013, and the inevitable Congressional melee that’s sure to expose itself during the debt ceiling negotiations, that might change. But for now, let’s revel in the light of a deal that’s saved millions of Americans from certain tax doom.
Next week we’ll talk a little bit about how this deal could affect your retirement plans, and why now is a good time to get started or finish up comprehensive estate planning. And if you can’t wait until then, or you have someone in mind that you think should speak to us sooner rather than later, I can be reached at any time to discuss your financial planning concerns at (561) 625-0900.
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