What does the term "The Fiscal Cliff" mean?

15 November 2012 / Uncategorized / Comments Off on What does the term "The Fiscal Cliff" mean?

What does the term "The Fiscal Cliff" mean?

You can’t pick up a newspaper or go online without seeing stories about the coming “fiscal cliff”, “tax cliff” or “taxmageddon”.  What exactly do these terms mean?  What is coming and how will affect you?  This article will discuss the situation that is behind all of these terms, and should shed some light on what you can expect for your own personal tax situation.

All of these terms refer to the time at the end of this year when the current tax rates for income, capital gains, gifts, and estates are scheduled to expire. Mostly overlooked by the news media are a large number of other tax provisions that are also scheduled to expire or have already expired.  Now, year-end tax law changes are nothing new; the implications for this year, however, are significant.  The so-called cliff represents the potential onset of federal tax increases and spending cuts (all slated to take effect January 1, 2013) that could have a substantial impact on the economy.  One analysis indicates that 90% of Americans will see a tax increase in 2013 under current law!

The country faced a similar situation at the end of 2010, when, after having over seven years to prepare for the sunset of the lower income, estate, and gift tax rates enacted in the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) and the sunset of the lower capital gains tax rates enacted by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), Congress had to scramble to prevent the tax rates from rising.  The House and the Senate finally enacting a short-term solution in mid-December 2010 in the form of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), which extended the ordinary income tax rates and the capital gains tax rates, reinstated the estate tax at a reduced rate, and extended a large number of expired or expiring provisions.

This year the country faces the same prospect. Many of the 2010 Tax Relief Act extensions expired at the end of 2011, and the rest expire at the end of this year. This article details the tax provisions that affect most of Widget’s clients that have expired and will expire if Congress does not act.  It, however, is NOT an all-inclusive list.

In August, the Senate Finance Committee approved a bill, the Family and Business Tax Cut Certainty Act of 2012 that would extend some, but not all, of the expired provisions through 2013. This may signal that, when Congress does act, it will not extend every expired provision because of the cost in lost federal revenue.  Tax provisions for individuals that the bill focused on included restoring the alternative minimum tax (AMT) patch and the deduction for state and local sales tax. Provisions for businesses included extending the research and development credit, the work opportunity credit, and the increased Sec. 179 expensing amounts. In all, the bill would extend or restore 11 provisions for individuals, 28 for businesses, and 13 energy incentives. It did not address the impending changes to income, estate, and capital gains tax rates.

The Joint Committee on Taxation estimated that renewing even this smaller list of provisions would cost more than $192 billion in lost revenue from fiscal year 2013 through fiscal year 2017. The fate of this bill is hard to predict.


Key Provisions Set To Expire At the End of 2012:

Tax rates

EGTRRA introduced a new 10% tax bracket below the 15% bracket for individuals and reduced the other tax brackets to 25%, 28%, 33%, and 35%. Those changes are scheduled to sunset after 2012 so that in 2013 the 10% rate will disappear (with income in that bracket reverting to the 15% bracket) and the other rates will revert to 28%, 31%, 36%, and 39.6%, respectively.

In 2003, JGTRRA also lowered the capital gains tax rate to 15% (0% for taxpayers in the 10% and 15% income tax brackets). These rate changes are also scheduled to expire after 2012. The rates will revert to 10% for taxpayers in the 15% income tax bracket and 20% for other brackets (8% or 18% for property held more than five years (but to qualify for the 18% rate, the holding period must begin after Dec. 31, 2000)). The taxation of qualified dividend income at capital gains rates will also expire at the end of 2012 and they will taxed as ordinary income.

EGTRRA’s repeal of the itemized deduction phase-out (Sec. 68(g)) and the personal exemption phase-out (Sec. 151(d)(3)) is also scheduled to expire after 2012.

Payroll tax reduction

The lower 4.2% rate for employees’ portion of the Social Security payroll tax will expire at the end of 2012 and revert to 6.2%.

AMT provisions

The 0% and 15% capital gains rates for the AMT, the AMT offset of the child tax credit, and the 7% AMT preference for excluded gain on the disposition of qualified small business stock are scheduled to expire at the end of 2012.

Bonus depreciation and Sec. 179 expensing

The 2010 Tax Relief Act sets the expensing limitation under Sec. 179 at $125,000 and the phase-out threshold amount at $500,000 for 2012. For tax years beginning after 2012, these amounts reduce to $25,000 and $200,000, respectively.

The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) expires at the end of 2012. The election to accelerate AMT credits in lieu of bonus depreciation (Sec. 168(k)(4)) also expires at the end of 2012.

Increased AMT exemption (Sec. 55(d))

Congress has temporarily increased the AMT exemption amount several times in recent years. These successive increases are commonly referred to as the “AMT patch.” The 2010 Tax Relief Act increased the AMT exemption amounts, but only for 2010 and 2011. With the AMT patch amounts now expired, the AMT exemption has reverted to its statutory amount: $45,000 for married individuals filing jointly, less 25% of alternative minimum taxable income (AMTI) exceeding $150,000; and $33,750 for unmarried individuals, less 25% of AMTI exceeding $112,500.

Estate, gift, and GST tax

The 2010 Tax Relief Act reinstated the estate, gift, and generation-skipping transfer (GST) tax at a rate of 35% and an estate, gift, and GST tax exemption of $5 million ($5.12 million in 2012, adjusted for inflation). In addition to the increase in the exemption amount, for decedents dying after 2010, the estate tax exemption of the first spouse to die is “portable.” That is, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount.

After 2012, if Congress does not act, the estate, gift, and GST tax regime that existed in 2000 will return. The exemption amount will be $1 million, and the top rate will be 55%! Ouch!


A variety of other temporary tax provisions are scheduled to expire at the end of 2012. These include tax credits, deductions, and various tax incentives.

Key Individual provisions:

  • Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2)));
  • The liberalized child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
  • The $1,000 child tax credit amount (scheduled to revert to $500) and the expanded refundability of the credit (Sec. 24);
  • The American opportunity tax credit (Sec. 25A);
  • The increased starting and ending points for the earned income tax credit and the increase in the credit amount for families with three or more qualifying children (Sec. 32);
  • Refundability of the credit for prior-year minimum tax liability (Sec. 53(e));
  • Exclusion from gross income for discharge of indebtedness on a principal residence (Sec. 108(a)(1)(E));
  • The exclusion for employer-provided educational assistance (Sec. 127);
  • The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221);
  • The higher contribution amount and other EGTRRA changes to Coverdell Education Savings Accounts (Sec. 530).

In addition to the large number of provisions scheduled to expire, many provisions expired at the end of 2011 and have not been reenacted.

  • The expanded adoption credit (Sec. 23) and adoption-assistance program (Sec. 137) amounts;
  • The nonbusiness energy property credit (Sec. 25C);
  • The deduction of up to $250 for certain elementary and secondary school teacher expenses (Sec. 62(a)(2)(D));
  • Deductibility of mortgage insurance premiums as interest (Sec. 163(h));
  • Deductibility of state and local sales tax instead of state income taxes on Schedule A (Sec. 164(b));
  • The above-the-line deduction of up to $4,000 for qualified tuition and related expenses (Sec. 222);
  • The tax-free treatment of charitable distributions from IRAs (Sec. 408(d)(8));
  • The District of Columbia first-time homebuyer credit (Sec. 1400C); and
  • The temporary 100% exclusion of gain from the sale of certain small business stock (Sec. 1202(a)).

There are many other expiring provisions for individuals that are not covered in this article due their obscure nature.

Key Business Provisions:

Many business tax incentives expired at the end of 2011. Perhaps the most significant of these are the expiration of the allowance for 100% first-year bonus depreciation (it is reduced to 50% for 2012) (Sec. 168(k)) and the expiration of the increased deduction amounts under Sec. 179. The Sec. 179 expensing limitation was reduced to $125,000 for 2012, and the phase-out threshold amount was lowered to $500,000. The inflation-adjusted amounts for 2012 are $139,000 and $560,000, respectively (Rev. Proc. 2011-52).

The Sec. 41 research and development credit also expired at the end of 2011, as did the work opportunity tax credit (Sec. 51(c)) (but portions were extended through 2012 for certain veterans by the Three Percent Withholding Repeal and Job Creation Act).

Various other tax credits aimed at businesses also expired:

  • The credit for plug-in electric vehicles (Sec. 30);
  • The biodiesel and renewable diesel fuel credits (Sec. 40A);
  • The new markets tax credit (Sec. 45D);
  • The new energy-efficient homes credit (Sec. 45L);
  • The energy-efficient appliances credit (Sec. 45M);
  • The alcohol fuel mixture, biodiesel, alternative fuel, and alternative fuel mixture excise tax credits (Secs. 6426 and 6427); and

Expired deductions and special depreciation rules (in addition to the expiration of 100% bonus depreciation) include:

  • 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e)(3)(E));
  • Charitable deduction for food inventory contributions (Sec. 170(e)(3)(C));
  • Increased charitable deduction for contributions of book inventory to public schools (Sec. 170(e)(3)(D));
  • Increased charitable deduction for corporate contributions of computer equipment to schools (Sec. 170(e)(6));
  • Special film and television production expensing rules (Sec. 181);
  • Brownfields environmental remediation expensing (Sec. 198);
  • The deduction for domestic production activities in Puerto Rico (Sec. 199(d)(8)).

There are many other expiring business provisions that are not covered in this article due their obscure nature.


Whatever Congress ends up doing, many of these tax provisions will affect the upcoming tax season. The IRS will need to program its computers and possibly redesign tax forms. The later in the year legislation is passed, the harder it will be for the IRS to have everything in place. And it is possible that Congress will not resolve things until sometime in 2013, leading to retroactive reinstatement of tax provisions and many amended returns.

Parts of the impending cliff, of course, go beyond taxes: As a result of the debt ceiling agreement reached last year, automatic government spending cuts are scheduled to take effect in 2013. The Supreme Court’s upholding of 2010’s health care legislation and Obama’s re-election means many health care reforms (and some taxes) will go into effect over the next few years. Together, these issues will have a large impact on all taxpayers.

This is a confusing mess for everyone when the tax laws continually change, but that has been the norm since 1913 when the income tax was first put in place.  We at Widget Bookkeeping and Tax, PA do our best to stay on top of the law changes so we can ensure our clients are paying the lowest amount of tax possible.  We would love to discuss your tax situation with you and help you pay less.


Widget Bookkeeping and Tax, P.A.

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