Fiscal Cliff – Wilson Rogers & Company

The Unavoidable 2013 Tax Season Delay

Back in 2010, the IRS was forced to delay when it began processing tax returns due to late passing legislation made by Congress. In a recent letter from Acting Commissioner Steven Miller, who wrote to Representative Sander Levin, who sits on the House Ways and Means Committee, the IRS warned that this could be the case in early 2013. Why? Well, as Congress works on the Fiscal Cliff, there are two other pieces of legislation that must also be voted upon. As noted in Commissioner Miller’s letter, these are:

Whether the parameters of the alternative minimum tax are revised (referred to as “the AMT patch”)
Whether any already expired tax deductions are revived and made effective for 2012 (the “tax extenders”).

AMT Patch Of the two items, this one poses the more significant challenge for the IRS. AMT applies to individual taxpayers with incomes above specific thresholds set by law. For many years, Congress has been “indexing” these amounts for inflation to prevent taxpayers from being subject to AMT. If this is not done, or Congress delays doing it, under current law the thresholds revert to much lower levels for 2012 – $33,750 for individuals and $45,000 for married taxpayers filing jointly. At these levels, approximately 33 million taxpayers would pay AMT for tax year 2012 (with returns filed in the spring of 2013). This is about 28 million more taxpayers who would pay the AMT than if the exemption amounts were increased as in the past.

Tax Extenders At the end of 2011, a number of other tax provisions affecting individuals expired. These include tax deductions for educators’ out-of-pocket classroom expenses, tuition and related fees for higher education, and state and local sales taxes. The challenge for the IRS on these items is whether or not legislation will be passed to extend these provisions again.

So just how delayed could the filing season be? According to Commissioner Miller if the AMT patch is enacted before the end of 2012, there would be minimal delays to opening the 2013 tax filing season for most taxpayers. This is because the IRS has already programmed it’s systems as if the patch will be enacted. However, if the AMT patch is allowed to expire, the magnitude and complexity of the changes necessary to get the system ready could delay the filing season for impacted taxpayers until late March 2013, if not even later. Conversely, processing would only be delayed by about four weeks if Congress decides to revive and extend already expired tax provisions.

What This Means For You

Tell people to spread the word. For some taxpayers, the timing of when they file and receive their refunds is critical to their financial situations. Being informed that there could be delays regarding the above could impact items such as how Christmas spending is arranged for.
Be prepared for the possibility that tax return processing and the issuance of refunds may be delayed this upcoming 2013. While you may be able to file starting in January, the IRS may hold these returns in a queue, which could create a processing backlog. Depending on the size of this queue, returns that are filed in January may not be processed until a few weeks later, if not several.

Start to get your documents ready and file as soon as you have your information. Firstly, you want to get your information in early so that if a queue does manifest, you are on the top of it and not the bottom. Secondly, make your tax preparers life a little easier. While the start of the filing season may move, the April 15^th deadline will be the same as it is enacted by law. With that being said, it will be a stressful time for most preparers and many will be thankful if you “help them help you” so to speak.

Be patient throughout the process. A lot of what may happen is largely out of the control of your preparer, the tax software companies and even the IRS. So while it may be a little frustrating, realize that we will all get through it if we just take the advice of our friends Telepopmusik and just breathe.

01/03/13 Update: So on January 1st 2013 HR 8, the American Taxpayer Relief Act of 2012, was passed by the Senate and the House of Representatives. This bill makes the AMT issue noted above mute as they have permanently patched AMT so it doesn’t have to be done every year. They also passed some of the extenders as well.

Everyone is still awaiting definitive guidance from the IRS, but at this point in looks like filing may open late January or early February.

01/08/13 Update: So the IRS has issued IR-2013-2 and announced today it plans to open the 2013 filing season and begin processing individual income tax returns on Jan. 30.

The IRS will begin accepting tax returns on that date after updating forms and completing programming and testing of its processing systems. This will reflect the bulk of the late tax law changes enacted Jan. 2. The announcement means that the vast majority of tax filers — more than 120 million households — should be able to start filing tax returns starting Jan 30.

The IRS estimates that remaining households will be able to start filing in late February or into March because of the need for more extensive form and processing systems changes.

Just what exactly is the Fiscal Cliff?

Lately there has been a lot of talk about the impending Fiscal Cliff and its potential to derail the current fragile US economy. However, there hasn’t been a lot of talk explaining exactly what it is or how it even came to be. In this post we’ll take a deeper look at the situation to determine if things are really all “doom and gloom” or if things are just being blown out of proportion.

The Fiscal Cliff Explained

In short, the “Fiscal Cliff” is a term used to describe the conundrum that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect. The following provisions of current law are what have brought us to this point:

Expiration of the Bush tax cuts extended by President Obama in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010;
Across-the-board spending cuts (“sequestration”) to most discretionary programs as directed by the Budget Control Act of 2011;
Reversion of the Alternative Minimum Tax thresholds to their 2000 tax year levels;
Expiration of measures delaying the Medicare Sustainable Growth Rate from going into effect (the “doc fix”), most recently extended by the Middle Class Tax Relief and Job Creation Act of 2012 (MCTRJCA);
Expiration of the 2% Social Security payroll tax cut, most recently extended by MCTRJCA;
Expiration of federal unemployment benefits, most recently extended by MCTRJCA and
New taxes imposed by the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.

Possible Effects of the Fiscal Cliff

The major concern behind all the “doom and gloom” talk is that if the current laws slated for 2013 go into effect, the impact on the economy could be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $487 billion, the Congressional Budget Office (CBO) estimates that gross domestic product (GDP) would be cut by four percentage points in 2013, sending the economy into a recession (i.e., negative growth). At the same time, it predicts unemployment would rise by almost a full percentage point, with a loss of about two million jobs. The nice little info graphic below illustrates all the components in play and what happens if lawmakers let all the policies go into effect (left side) vs. if some type of tax and spending concessions are made (right side).

Dealing with the Cliff

Generally speaking, U.S. lawmakers have three choices to deal with the Fiscal Cliff, each of which brings about a different outcome as it pertains to economic growth and budget deficits:

They can let the current policy scheduled for the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – go into effect. The plus side: the deficit, as a percentage of GDP, would be cut in half.
They can cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe. The flip side of this, of course, is that the United States’ debt will continue to grow.
They could take a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth.

Anticipated Outcome?

Given how late Congress acted in 2011 regarding the debt ceiling (i.e. item number two under “The Fiscal Cliff Explained” above), the cost of indecision is likely to have an effect on the economy before 2013 even begins. The CBO anticipates that a lack of resolution will cause households and businesses to begin changing their spending in anticipation of the changes, possible reducing GDP before 2012 is even over.

Having said this, it’s important to keep in mind that while the term “cliff” indicates an immediate disaster, the impact of the changes will be gradual at first. What’s more, Congress can act to change laws retroactively after the deadline. As a result, the fiscal cliff won’t necessarily be an impediment to growth even if Congress doesn’t address the issue until after 2013 has already begun.

However, one thing to note is that the US debt picture is not in a good place currently. Pictured below are some nice graphs on projected budget deficits and historic US federal debt levels to help put things in perspective. We can only hope that our politicians and lawmakers will sit down NOW and make those difficult decisions to help right a situation that could potentially get much worse in the years to come.

Budget deficits, projected through 2022. The “CBO Baseline” shows the effects of the fiscal cliff under current law. The “Alternative Scenario” represents what would happen if Congress extends the Bush tax cuts and repeals the Budget Control Act-mandated spending reductions beyond the end of 2012.

US federal debt from 1940 to 2022. The right side of the diagram projects what would happen to the debt if Congress (a) allows current laws to take effect and reduce the deficit (the baseline) or (b) extends the current policies, such as keeping tax cuts in place (the alternative).

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