Update on the Fiscal Cliff, Taxes and What Happens Next 1

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Update on the Fiscal Cliff, Taxes
and What Happens Next
Mary Burke Baker
Michael W. Evans
Hon. James T. Walsh
January 4, 2013
Copyright © 2012 by K&L Gates LLP. All rights reserved.
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Background
Congress passed the American Taxpayer Relief Act
on January 1, 2013.
 The bill is largely a tax package.
 Makes individual tax rates permanent.
 Delays sequestration by two months.
 Raises $620 billion compared to 2012 policy
baseline.
 JCT: raises deficit by $3.915 trillion over 10 years.
 CBO: raises deficit by $3.971 trillion over 10 years.
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What Does the American Taxpayer
Relief Act Actually Do?
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Key Components
 Tax Rates:
 Permanently extends 2001/2003 rates for those
earning less than $400k/$450k in taxable income.
 Allows 2001/2003 rates to expire for income
above the $400k/$450k threshold.
 Raises rate on this income from 35% to 39.6%.
 Capital Gains/Dividends:
 Permanent 15% rate below $400k/$450k.
 Permanent 20% rate above $400k/$450k.
 Note: does not eliminate 3.8% surcharge imposed
by the health reform law.
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Key Components, cont’d
 Estate Tax:
 Permanent 40% rate with $5 million per person
exemption adjusted for inflation.
 Alternative Minimum Tax:
 Permanent patch, adjusted for inflation.
 PEP and Pease:
 Reinstated for those with adjusted gross income
over $250k/$300k.
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Key Components, cont’d
 Tax Extenders:
 One-year retroactive extension and one-year
prospective extension of dozens of temporary
business tax provisions.
 Senate Finance Committee extenders package
plus “bonus” depreciation.
 “Stimulus” Tax Credits:
 Five-year extension of current tax credits,
including AOTC, CTC, and EITC.
 Medicare Doc Fix:
 One-year patch.
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Key Components, cont’d
 Unemployment Insurance:
 One-year extension of additional benefits.
 Farm Bill:
 General extension of current law through end of
FY 2013.
 Roth IRA Conversion
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What’s Not in the Bill?
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Payroll Tax Cut Extension
Tax Reform Framework
Entitlement Reform
Debt Ceiling
Sequestration (beyond February 2013)
Numerous Tax Extenders:
 Economic recovery incentives
 Disaster relief incentives
 Energy incentives (e.g., ethanol, section 1603)
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What Does It All Mean?
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What Does It All Mean?
The bill does not reduce the debt.
 Virtually no spending cuts.
 New revenue, but this is “spent” to extend other
tax breaks and programs.
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What Does It All Mean?
Billions
American Taxpayer Relief Act of 2012 - Revenue Loss
(over ten year period)
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
Permanent extension of
2001/2003 tax rates
AMT Patch
Extension of 2009 Stimulus
Tax Breaks
Tax Extenders
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What Does It All Mean?
The bill reflects President Obama’s priorities.
 Tax provisions tended to favor low- and
middle-income Americans.
 Lower tax rates
 College tuition breaks
 EITC, CTC, others
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What Does It All Mean?
Republicans succeeded in some respects but
failed to make ground in others.
 Maintained 2001/2003 rates for nearly all
Americans.
 Also scored victories on capital gains and
dividends, as well as the estate tax.
 However, they did not make progress on
reducing spending.
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What Does It All Mean?
The economic impact of the bill is uncertain.
 Taxes are going up 3% on almost all Americans
(payroll tax increase and health care taxes).
 Taxes going up even more for the wealthy.
 The net short term effect is still negative.
 The effect of long-term certainty remains unclear.
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What Does It All Mean?
New taxes in 2013.
 Highest marginal rate:
 Highest capital gains and dividend rate:
 Estate tax:
 Medicare tax on investment income:
 High-income FICA tax:
 Reinstatement of payroll tax:
 PEP and Pease phase-out
39.6%
20%
40%
3.8%
0.9%
2%
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The Rates Add Up
Capital Gains & Dividends
Previous top rate
15%
Increase (total 20%)
5%
Medicare tax on
investment income
Total:
3.8% (>$200k/$250k)
23.8%
Ordinary Rates – Earned Income
Previous top rate
35%
Increase (total 39.6%)
4.6%
High earner FICA
0.9% (>$200k/$250k)
Payroll tax increase
Total:
2%
42.5%
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What Happens Next?
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Upcoming Events and Deadlines
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January 21: Inauguration address.
January/February: State of the Union address.
February: Secretary Geithner steps down?
February/March: Government reaches debt
ceiling.
 Treasury using “extraordinary measures.”
 February/March: President releases FY 2014
budget request.
 March 1: Budget sequestration takes effect.
 March 27: Continuing resolution expires.
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Fiscal Cliff II?
 All eyes will be on House Republican leadership
yet again.
 Rank-and-file House Republicans will be looking
for leadership to use debt ceiling to extract
significant spending cuts.
 Democrats will continue to push for increased
revenues and preserve entitlement programs.
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The Narrative is Still Developing
 Republicans: Taxes have gone up. Now it’s time
to reduce spending.
 Democrats: Any future agreement must also be
balanced.
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Strong Momentum for Entitlement Reform
Lawmakers have numerous options available.
 Social Security:
 Change CPI formula
 Gradually raise eligibility age
 Medicare:
 Reduce payments
 Raise eligibility age
 Savings through innovative programs that improve
care yet lower costs
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Tax Reform Is Very Much Alive
 Some see tax reform as the best way to raise
more revenue.
 Others want “revenue neutral” tax reform that
closes some loopholes but lowers overall rates.
 Easier said than done.
 Difficult to reach consensus on specific loopholes
to close.
 Any Fiscal Cliff II deal is likely to include a
framework for tax reform.
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Tax Reform Is Very Much Alive
 Chairmen Camp and Baucus have invested a
huge amount of time and effort in tax reform and
remain committed to it.
 More than 50 hearings in 112th Congress.
 New Senate Finance Committee members Pat
Toomey (R-PA) and Rob Portman (R-OH) are
interested in tax reform, as well.
 Business leaders are also pushing for reform.
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Potential Tax Reform Targets
 Corporate tax expenditures will be most at risk
 High revenue-raising potential
 Easily identifiable and measurable
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International reform
Pass-through entities
Carried interest
Retirement savings
Capping deductions
Large individual tax expenditures
 E.g., mortgage interest deduction
 Popular, but account for large revenue loss
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Pulling It Together
 Fiscal Cliff I was not the grand bargain that many
hoped to achieve.
 Out of the frying pan, into the fire.
 The debate will be contentious.
 Fiscal Cliff II continues to pose significant tax
risks—whether reform is comprehensive or more
targeted.
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Questions?
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Contact Information
Michael Evans
Mary Burke Baker
Hon. James T. Walsh
Partner
(202) 661-3807
[email protected]
Government Affairs Advisor
(202) 778-9223
[email protected]
Government Affairs Counselor
(202) 778-9321
[email protected]
Hon. Barton J. Gordon
Rick Valentine
William Kirk
Partner
(202) 778-9073
[email protected]
Partner
(202) 661-3802
[email protected]
Partner
(202) 661-3814
[email protected]
Cindy O’Malley
Dennis Stephens
Scott Aliferis
Government Affairs Counselor
(202) 661-6228
[email protected]
Government Affairs Counselor
(202) 661-6229
[email protected]
Government Affairs Advisor
(202) 661-3865
[email protected]
Karishma Page
Ryan J. Severson
Andrés Gil
Associate
(202) 778-9128
[email protected]
Associate
(202) 778-9251
[email protected]
Associate
(202) 778-9226
[email protected]
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