Jumping off the Fiscal Cliff

The US congress decided earlier this month not to take a leap off the fiscal cliff, but instead decided in favor of a controlled landing. The new American Taxpayers Relief Act (ATRA) or fiscal cliff laws will have a major impact on all taxpayers. In this posting I will focus on items that will impact Americans in Canada or Canadians with US tax obligations.

Tax Rates:

Prior to this law being passed, the Bush tax cuts were set to expire at the end of 2012. All rates would have gone up for all taxpayers. As part of the ATRA, the 2012 tax rates were made permanent with one additional bracket. This new bracket will begin at $400,000 for single filers, $425,000 for head of household and $450,000 for those filing jointly. With these rates now being permanent and being indexed annually for inflation, individuals will be able to plan their affairs without worrying about rates expiring. The following tables will show the expiring rates, what the rates would have been without the ATRA and what the rates will be going forward.

2012 Rates – Bush tax cuts

 Single Married – Joint Head of Household
10% 0-$8,950 0-$17,900 $0-12,750
15% $8950-$36,250 $17,900-$60,550 $12,750-$48,600
25% $36,250-$87,850 $60,550-$146,400 $48,600-$125.450
28% $87,850-$183,250 $146,400-$223,050 $125,450-$203,150
33% $183,250-$398,350 $223,050 -$398,350 $203,150-$398,350
35% $398,350 & up $398,350 & up $398,350 & up

Rates scheduled upon expiry of Bush tax cuts

 Single Married – Joint Head of Household
15% 0-$36,250 0-$60,550 0-$48,600
28% $36,250-$87,850 $60,550-$146,400 $48,600-$125.450
31% $87,850-$183,250 $146,400-$223,050 $125,450-$203,150
36% $183,250-$398,350 $223,050 -$398,350 $203,150-$398,350
39.6% $398,350 & up $398,350 & up $398,350 & up

 

2013 new permanent rates in effect

Rates

Single

Married – Joint

Head of Household

10% 0-$8,950 0-$17,900 $0-12,750
15% $8950-$36,250 $17,900-$72,500 $12,750-$48,600
25% $36,250-$87,850 $72,500-$146,400 $48,600-$125.450
28% $87,850-$183,250 $146,400-$223,050 $125,450-$203,150
33% $183,250-$398,350 $223,050 -$398,350 $203,150-$398,350
35% $398,350-$400,000 $398,350-$450,000 $398,350-$425,000
39.6% $400,000 & up $450,000 & up $425,000 & up

 

Note that rates for those married filing separately are always 50% of the married filing joint.

Impact on Canadians

This new law will be beneficial to Canadians. With the lower rates being made permanent, most working Canadians will be able to continue not owing very much each year to Uncle Sam. However, those wealthy individuals who have large deductions in Canada might find themselves in a situation where they are unsure from year to year as to whether they owe money.

Extension of Capital gains and dividend rates:

Prior to this law, the reduced rates on Dividends and capital gains would have been eliminated. This would have resulted in dividends and long term capital gains being taxes as ordinary income. Under the Bush cuts, qualified dividends and long term capital gains were taxes at 15% flat. In addition, those people in the 10% bracket paid no tax on dividends or long term capital gains. The new law extends the 0 and 15% rates across the board and establishes a 20% tax on those in the highest income tax bracket.

Impact on Canadians:

The extension of these tax rates is beneficial. Had this law gone into effect, these items would be taxed as ordinary income and that would have resulted in much higher taxes on these items in the USA than in Canada. This could have left many average Canadians with taxes payable in the USA each year. This would have especially hit retirees hard with much of their incomes being investment based, rather than employment based. With these new rates in effect, the current system where Canadian taxes should cover the American taxes due will continue. The only people who are likely to have taxes due are the wealthier Canadians with long term gains as Canada generally taxes these at lower rates.

Alternative Minimum Tax (AMT)

Prior to this law being passed, AMT was expected to hit in 2013 at $33,750 for individuals, $45,000 for couples & $22,500 for those married but filing separate returns. This would have meant many Americans being caught by AMT. Even more so, those living abroad and filing separately as their spouse has no obligation, would almost certainly be caught by AMT. With this law, the AMT hits now at $50,600 for individuals, $78,750 for those married filing jointly and half of that for those filing apart from their spouse.

Another benefit to this law is that now AMT is to be indexed annually for inflation. It used to be that congress needed to pass a patch for AMT annually in order for it not to keep capturing more and more people. With this indexation, fewer people will be trapped annually.

Impact on Canadians:

Once again, this law brings positive news to Americans in Canada. With the higher exemption amounts, fewer Canadians will be caught. In addition, with the rates being fully indexed for inflation, there will be no annual worries as to whether someone will be caught by AMT.

Estate tax:

Prior to this law passing, it was expected that the estate tax rate for 2013 and subsequent years would be 55% for estates valued at above $1M. For those dying in 2012, the tax rate was 35% on estates larger than $5.12M.  With this new law, the 2012 limits are now permanent and will be indexed for inflation. The expected exemption for 2013 is approximately $5.2M. The tax rate on these estates will be 40%. In addition, the exemption amount can now be transferred between spouses, allowing for a much larger exemption for a family.

Impact on Canadians:

This law will impact all Canadians who have US estate tax liability. However, those families with estates between 1M and 5.2M will now not be required to pay anything. This will greatly reduce the number of Canadians with exposure to US estate tax.

Another group who may benefit from this are those who own real estate in the US. As estate tax is charged on all US property, Canadians owning property can be subject to estate tax. The increased threshold and reduced rate from what were the expected rates is a welcome change as it will exempt many Canadians from these taxes. The same formulas as before will be in place to calculate non-resident exemptions so this will just increase the exemption amount from what was expected.

Child tax credit/Additional child tax credit:

This is one of the few refundable credits available to Americans living abroad. In 2012, this credit was worth $1,000/child and it was scheduled to become $500 in 2013. However, with the passage of this law, the credit is permanently restored at $1000/child going forward. The refundable portion is set at $1000/child through 2017.

Impact on Canadians:

The extension of these credits is good news for Americans in Canada who are raising children. Through proper tax planning, they will now be able to get a refund of $1000/child without paying anything into the system up front.

These are some of the key features in the fiscal cliff law that will impact Americans in Canada. There are some other general clauses or businesses laws in place as well. For a summary of the law and other attributes, check out the following website. http://www.parkertaxpublishing.com/public/ATRA_2012_Analysis.html?goback=.gde_1884032_member_201223333

If you have any questions regarding how the fiscal cliff impacts you, your family or your business, make an appointment with our tax experts to guide you through and to help you plan for dealing with the American tax code.