Getting a Perm: Subtle Implications of the Fiscal Cliff Tax Bill

By now, just about everyone is aware of the Senate and House votes over the New Year’s holiday that “settled” the near-term fiscal cliff.

We will be sending out a separate communication in the following days with more specific details about the Taxpayer Relief Act of 2012. Separate from those details, however, is an interesting aspect of the negotiated compromise having to do with the concept of permanence.

One of the bigger issues with the income and estate tax rates over the last decade is that the rates were established with sunset clauses, meaning that they expired after some period of time. (This was due to a Senate rule known as the Byrd Rule.) Rates were set to expire first in 2010 and then again in 2013 after a two-year extension; at their expiration tax rates were supposed to lapse back to what they’d been before the rate reductions of the Bush tax cuts.

Similarly, those familiar with the Alternative Minimum Tax (AMT) know that each year Congress has had to issue a “patch” to increase the AMT exemption amount, as the original legislation that created the AMT did not allow for inflation-adjusted increases in the exemption amount. Tax professionals usually take it for granted that Congress would act to issue the patch, but there was nothing binding.

The Taxpayer Relief Act of 2012 does away with sunset clauses, lapses and the need for annual patches, at least for marginal tax rates, estate taxes and Alternative Minimum Taxes. Both the existing marginal rates and the newly created 39.6% bracket are made permanent, meaning that they will not expire at some point in the future. Similarly, both the estate tax exemption amount of $5.12 million (adjusted in future years for inflation) and the newly established estate tax rate of 40% are made permanent. They won’t phase out over time, nor will they change. And lastly, the Act makes permanent the series of AMT patches from the last decade and establishes that future exemption amounts will be adjusted for inflation.

It’s important to keep in mind that nothing tax-related is ever permanent, with the exception of always being required to pay. Congress could very well rewrite the rules a couple of years from now and change just about whatever they want.

That said (and leaving the politics of the Tax Act aside), the “permanence” the Act creates for income and estate taxes helps from a financial and tax planning perspective. Without the near-term threat of disappearing or rising tax brackets, we can be a little more comfortable in our tax projections. And the permanence of the estate tax exemption (as well as the permanent ability to transfer any unused exemption amount to a surviving spouse) makes complicated trust planning a lot less necessary for many people.

Again, Woodward Financial Advisors will be sending a separate communication with more details about the Act and its implications. In the meantime, if you have any questions about this new tax legislation, please don’t hesitate to contact us.