By Eileen Ambrose, The Baltimore Sun
11:35 PM EST, January 4, 2013
For better or worse, Marylanders may be more affected by the fiscal cliff tax deal than residents in other parts of the country.
Maryland is one of the wealthiest states, and its residents have the nation's highest median income. That means they likely will feel the impact of a higher income tax rate on the rich as well as a phase-out of deductions on the not-quite-so-rich.
On the other hand, many well-to-do households here will benefit from an inflation-adjusted $5 million exemption from federal estate taxes. Congress also provided permanent relief to the alternative minimum tax that often hits residents in high-tax states like Maryland.
Maryland financial advisers report receiving few, if any, calls from clients about the new law that averted tax increases and put off automatic spending cuts that combined were known as the fiscal cliff. They are still digesting all the tax changes and trying to determine whether their clients need to take action. But many are just glad lawmakers finally reached a resolution.
"There is a level of certainty — for the near future anyway," said Don Lord, a financial adviser with The Family Firm in Bethesda.
Most workers will see their incomes pinched by the new tax law in their first paycheck of the year, when their contributions to Social Security go back up to 6.2 percent, after two years at only 4 percent. But other than that, most tax increases are geared toward high-income households, and Maryland has plenty of those.
Here are some of the key tax changes affecting them:
Top tax rate: Congress restored the top tax rate of 39.6 percent on taxable income above $400,000 for individuals and more than $450,000 for joint filers. This affects less than 1 percent of taxpayers.
But Denise Leish, principal of Money Plans in Silver Spring, who works with high-net-worth individuals, said the jump in the top tax rate will affect about half of her clients.
Additionally, Maryland raised income taxes on high earners last year, she noted.
"If you live in Maryland, you are getting hit twice as hard," she said.
Dividends, capital gains: The George W. Bush-era low tax rates on dividends and capital gains remain for all but the wealthiest. Singles with taxable income above $400,000 and joint filers with more than $450,000 in income will now pay a rate of 20 percent, instead of 15 percent.
"We have a lot of clients in that range. It's better than it could have been," said Patrick Collins, managing director of the private client group at Greenspring Wealth Management in Towson.
Dividends, for instance, were slated to once more be taxed like regular income, which could have been as much as 39.6 percent.
Starting this year, too, high-earners will have to pay an additional 3.8 percent on investment income — dividends, interest, rental income and capital gains. This is a provision of the Affordable Care Act, not the fiscal cliff law. This extra tax applies to singles with more than $200,000 in income and joint filers earning more than $250,000.
These changes are making financial planners re-evaluate the holdings in clients' accounts.
Lyle K. Benson, president of L.K. Benson & Co. in Towson, said he's not going to change his clients' mix of stocks and bonds, but he may shift income-generating securities from taxable accounts to tax-deferred retirement plans.
Phase-outs: Personal exemptions and itemized deductions will once more be phased out for high earners. This begins once income exceeds $250,000 for singles and $300,000 for joint filers.
Earn enough, and personal exemptions for taxpayers and their children can be wiped out. But itemized deductions can't be reduced by more than 80 percent, said Mark Luscombe, principal analyst with CCH, an Illinois provider of tax information. And certain deductions, such as those for theft, casualties, medical expenses and investment income are exempt from any phase-out, he said.
It wouldn't be unusual for a married professional couple to reach that $300,000 threshold and find their deductions shrink, Leish said.
Alternative minimum tax: This is an arcane tax created decades ago to capture rich tax avoiders, but it now ensnares some middle-income families because it was never adjusted for inflation.
Basically, taxpayers figure their liability under the regular income tax and AMT, and pay the higher of the two. The AMT doesn't allow a deduction for state and local income taxes, which is why residents in high-tax states like Maryland tend to trigger the AMT.
For years, Congress made temporary fixes to prevent millions of taxpayers from owing the AMT, but the last patch expired in 2011. Without congressional action, many Marylanders would have come to know the AMT because the exemption would have reverted to older, much lower levels.
"It would have been impossible to escape" for most state residents, said Michael Kitces, director of research for Pinnacle Advisory Group in Columbia.
But under the new law, Congress passed permanent relief by raising the amount of income exempted from the AMT and indexed it for inflation. For tax year 2012, the exemption amount is $50,600 for singles and $78,750 for joint filers.
"That will affect a lot of people in the $150,000 to $300,000 range," Benson said. "They are the people who would have been very hard by the AMT if that hadn't been fixed."
Estate tax: Last year, a person could shelter $5.12 million from federal estate taxes, which are paid when a deceased person's assets are transferred to someone else, and any money above that was taxed at 35 percent.
But the amount an individual could shelter from the tax was set to drop to $1 million this year, and the excess could be taxed at a top rate of 55 percent.
Fearing the worst, Maryland lawyers worked frantically to help clients set aside millions of dollars in trusts for heirs before the law changed. As it turns out, Congress maintained the 2012 limit and indexed it for inflation — a more generous tax break than many expected. The maximum tax rate on larger estates, though, was bumped up to 40 percent.
"I haven't had any clients call me up with buyer's remorse," said Jeffrey Gonya, an estate planning lawyer in Baltimore who was among those trying to beat the year-end deadline. "It's still a good thing to do."
Taxes are just one part of the fiscal cliff. Congress delayed the automatic spending cuts for two months — which also will affect many Marylanders who make their livelihood from the government.
Having watched Congress in action, Rockville financial planner Christopher Brown said it's made him consider investing in the Congressional Effect Fund.
"The theory is that Congress creates uncertainty," which is bad for stocks, Brown said. So when Congress is in session, the fund invests in government securities, and switches to an S&P 500 index stock fund when lawmakers are in recess, he said.
"It's done pretty well," Brown said.
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