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In an early morning session, the Senate approved a measure on tax increases and spending cuts. The measure now goes to the House of Representatives. Steven Sorhus, a certified public accountant at SouthHouse CPA LLC in Kirksville, breaks it down for us.

Question: What is the fiscal cliff issue all about?

Answer: In the past decade there has been a lot of legislation that was set to expire on Dec 31 2012. The fiscal cliff refers to the consequences of not extending those provisions.

Question: What is the current state of affairs?

Answer: Lawmakers are still in negotiations and are expected to vote on a compromise this afternoon.

Question: What are some common misperceptions you have heard about the Fiscal Cliff?

Answer: The most common is that this will affect the 2012 filing season. These provisions are for the tax year beginning today, not affecting the tax year which ended yesterday.

Question: What temporary provisions are of most concern to your clients?

Answer: The Estate Tax, which is the tax based on the value of all of your possessions when you pass away is a major concern.  In 2001 congress began to phase it out, until it was ultimately repealed in 2010. In 2011 it was back, but excluded a lot of taxpayers. The fiscal cliff puts the exclusion level back to 2001, meaning a lot more taxpayers need to worry about the impact of the tax to their estate

Question: And how did the Estate tax rollercoaster affect Heartland taxpayers?

Answer: Many Heartland farms are valued between the $1M and $5M level, leaving those farm owners uncertain about whether or not to implement gifting plans or other estate reducing strategies. Most estate reducing strategies have permanent, potentially negative consequences. Some taxpayers began estate reduction plans unnecessarily, if the deal increases the exemption level. Some taxpayers delayed reducing their estate and lost a year of gifting in an estate reduction plan. The Income Tax marginal rates were also scheduled to increase to pre-2001 levels

Question: Will that affect Heartland taxpayers?

Answer: Yes, but less you might think. We have a progressive marginal rate system of taxes. That means for a single taxpayer the first $8,500 of taxable income are taxed at 10%, even if you make lots of money and your last $1 is taxed at a potentially higher rate. The effective tax rate is always lower than the marginal tax rate, and often much lower. For example, if a single taxpayer makes $35,000 the marginal tax rate is 25%. After the effects of the standard deduction, personal exemption, and lower marginal rates are calculated the tax due on that income is only $3362.50, an effective rate of 9.6%. One provision that affects taxpayers in a real way is the 2% Social Security payroll tax hike. This affects most wage earners as that 2% will be (would have been) taken out of every paycheck at an effective  2% rate (in most cases).

Question: What is the most controversial provision?

Answer: I would have to say the capital gains rate. In 2012 one was taxed either 0% of 15% on long term capital gains. This was the main cause of Warren Buffett paying a lower effective rate than his secretary. Proponents argue that encouraging capital investing has benefits that indirectly positively affect the entire economy.

Question: Any other expiring issues?

Answer: Yes, there are mandatory spending decreases, the AMT patch, unemployment extended benefits, and a lot of other issues, but those we have talked about are the issues that are of the most concern to average taxpayers.

Question: Was coming to an agreement a win, or did we lose an opportunity?

Answer: That depends on your perspective. If you are retired living on Social Security, most tax hikes won’t affect you. If you want a more responsible federal government these expirations will raise more revenue and reduce spending. Many economists worried about the ripple effect of a more fiscally conservative government in this environment, others worry about the long term ripple effect of a less fiscally conservative government.

Steven Sorhus, CPA

SouthHouse CPA LLC

715 S. Baltimore Suite B

Kirksville, Mo 63501

660-988-9011