Understanding The Fiscal Cliff Legislation
By Victor Kostro // January 25, 2013
BREVARD COUNTY • MELBOURNE, FLORIDA–It’s been over three weeks since Congress drafted and passed legislation to avoid what was commonly referred to as “The Fiscal Cliff.” Is it clear to you what really happened and how that legislation may affect you?
The legislation in large part made permanent the system of estate and income tax that has been in effect for the past two years. The new law also delayed until March some important spending cuts that must take place due to a process called “sequestration.” It is these additional cuts that could have a significant impact on our senior population and their loved ones.
What Was Passed
Estate taxes. An estate tax is a federal tax (and in some states also includes a state tax) on the transfer of a deceased person’s assets to his heirs and beneficiaries, and can include prior transfers made to those heirs and beneficiaries. However, under federal law, there is a certain amount that can be transferred without incurring any tax liability. In 2010, every individual could transfer (gift) up to $5 million tax-free during life or at death to avoid paying estate taxes on that amount. This amount is called the “basic exclusion amount” and is adjusted for inflation (usually on an annual basis). In 2012 it was raised to $5.12 million per person.
This year’s new “fiscal cliff legislation” did not change how much an individual could transfer during life or at death to avoid paying federal estate taxes on that amount. And, on January 11, 2013, the IRS announced that the estate tax exclusion amount for individuals who die in 2013 is now $5.25 million, as the prior figure has now been adjusted for inflation. What if no action had been taken with regard to estate taxes? Without the new legislation, the $5.12 figure would have automatically reverted to $1 million per person, and the rate for most estates would have gone up to 55%. Instead, the only thing the new legislation changed was the gift and estate tax rate, which has gone up to a top rate of 40%, from a maximum of 35% in 2012.
Married couples. The new legislation did not change prior law that stated that spouses do not have to pay estate tax when they inherit from the other spouse. Rather, when the first spouse dies, the other spouse can inherit the entire estate and any estate tax due would be postponed until the second spouse dies. This is called the “marital deduction.”
If the surviving spouse is not a U.S. citizen, then there are restrictions on how much can be passed to the surviving spouse tax-free. It is also important to remember that this type of tax benefit between spouses is not always automatic – any married couple who may be subject to estate tax should seek the advice of an attorney to make sure their estate plan is properly set up to take advantage of this particular tax incentive.
Changes to the income tax rules. In prior years, everyone enjoyed a 2% Social Security tax reduction as a stimulus measure. Under the 2013 legislation, this “tax holiday” was not extended; therefore, everyone will see a decrease in their net pay. Ordinary income tax rates increase from 35% to 39.6% for singles earning more than $400,000 a year ($450,000 a year for married couples). All other ordinary income tax rates effective in 2012 were made permanent.
For those individuals earning over $250,000, and for married couples who earn over $250,000, there is a new Medicare 0.9% surtax on ordinary income and a new 3.8% surtax on investment income. These additional taxes were part of the 2010 health care legislation, much of which begins implementation in 2013. The top capital gains and dividend rate increased to 20% for those earning more than $400,000 a year ($450,000 for married couples).
Additional Cuts Are on the Way
The current fiscal cliff legislation did not address the automatic spending cuts that were to take place on January 1, 2013. Instead, the automatic cuts, known as sequestration, were pushed back two months to March 1, 2013. Sequestration was one portion of the spending cuts included in the Budget Control Act, passed and signed in August 2011. The Budget Control Act of 2011 allowed the president to raise the debt ceiling by $2.1 trillion, and it instituted two rounds of significant spending cuts. One round of cuts involved government programs like defense spending, education funding, the FBI and other government agencies that would receive automatic budget cuts relative to their scheduled growth over the next 10 years.
The second half of the spending cuts was supposed to be decided on by Congress through a Joint Select Committee on Deficit Reduction. This Committee (referred to as the “super committee”) was to come up with a list of cuts that would then be put to Congress for a full vote. If the committee couldn’t agree on the cuts, $1.2 trillion in further spending reductions over 10 years would be implemented starting Jan. 1, called the “sequester.”
No cuts have yet been agreed upon, and the automatic spending reductions have been moved back to March 1, 2013, to allow Congress time to come to an agreement. Programs like Medicare, Medicaid and Social Security have been the topic of discussion for the second portion of the spending cuts. Everyone would be wise to monitor the progress of Congress as it pertains to these spending cuts and how they will impact our senior population and their families.
The fiscal cliff legislation is in place; however, there is more legislation to occur that could have a significant impact on those affected by programs like Medicare, Medicaid and Social Security. While many families may not be affected by the current estate and income tax rules, there are many who could have their life savings consumed by long term care costs. If you would like to learn more, please contact an attorney, accountant or financial planner of your choice.
ABOUT THE AUTHOR
Victor S. Kostro is an attorney in private practice with the law firm of O’Brien, Riemenschneider & Wattwood, P.A. He has extensive experience as a corporate, transactional, healthcare attorney having served as Associate Corporate Counsel/Corporate Risk Manager for Health First, Inc. In this role, Vic provided representation related to physician employment, practice sales/acquisitions, regulatory and compliance issues, peer review and disciplinary actions, and counseled on issues related to fraud and abuse, anti-kickback laws, Stark, self-referral and the False Claims Act. In addition, Vic managed the entity’s Risk Management Department, which included oversight of all medical negligence and personal injury claims asserted against the entity, its hospitals and physicians. Vic is well versed in medical practice entity formation, and contractual matters, employment, shareholder and partnership agreements, purchase and sale agreements, estate planning and asset protection. Vic holds a Master of Laws in Taxation from the University of Florida.