Late in the evening on January 1st, the House of Representatives approved a Senate-backed plan that scales back the broad tax hikes and spending cuts that officially took effect at the start of 2013.  The republican House voted final approval for the bill by 257-167 late Tuesday.

The “cliff” deal led to a 300 point rise in the Dow on Wednesday, the largest single-day gain in a year.  On Friday, the S&P 500 closed on a five-year high.

Most of the changes will affect only the most affluent Americans in the higher tax brackets.  Here are the key points of the deal:

TAXES

There is a new top rate of 39.6%, compared with 35% for 2012. The threshold for the top rate is $450,000 of taxable income for married couples filing jointly and $400,000 for single filers.

President Obama originally wanted a tax increase starting at the 250k married / 200k single level.

This increase is expected to raise over $396 billion over the next ten years.

Note:  In Canada depending on the province, the top tax rate is between 39%-48% (BC: 43.7%, Ontario: 46.41%) and starts at about $132,000 (slightly different for each province).

INVESTMENT INCOME

The bill does raise rates on long-term capital gains and dividends for top-bracket taxpayers. People who owe at the 39.6% level (same 450k married /400k single threshold) for income tax will pay 20% on all their net long-term gains as opposed to 15% in 2012.

The increase is expected to raise over $56 billion over the next ten years.

The 15% rate will continue to apply to taxpayers in the 25%, 28%, 33% and 35% income tax brackets.  Those in the 10% and 15% brackets will continue to have a zero rate on capital gains and dividends.

Note: In Canada, for eligible Canadian dividends, most Canadians will not pay any taxes on dividends if their net income is under 40k.  After the 40k mark, depending on the province and income, they are taxed at somewhere between 10-30%.  Capital gains tax is simpler; Canadians are taxed on 50% of capital gains (meaning if you’re in the 30% tax bracket, you’ll pay a 15% tax on capital gains).

ESTATE TAX

The estate- and gift-tax exemption will remain $5 million or more per individual.  However, the current 35% top tax rate on amounts above the exemption will increase to 40%.   President Obama wanted to exemption lowered to $3.5 million.

In addition, the estate and gift tax will remain “unified,” meaning that an individual can use the entire exemption to make gifts while alive.  Also, portability rules will continue to apply.  Any unused portion of the exemption can be transferred and used by the surviving spouse.

PAYROLL TAX CUT

Lawmakers allowed the immediate expiration of a two-year, 2% cut in the Social Security payroll tax.  The premium will rise to 6.2% of wage income up to a cap of $113,700.  The break had put an extra $1,000 in the wallets of typical families earning $50,000 a year the past couple years.  For most Americans, this will be the biggest effect of the bill.

Note:  In Canada, CPP premiums are 4.95% of gross income for employees or 9.90% for self-employed workers to a cap (YMPE – Yearly Maximum Pensionable Earnings) of $50,100 for 2012.

ALTERNATIVE MINIMUM TAX (AMT)

The bill will permanently stop the alternative minimum tax from raising levies on millions of middle-income families.  Had this fix not been made, the AMT would have applied to 34 million taxpayers in 2012 and would also have severely disrupted the coming tax-filing season.

The AMT was originally intended to apply to wealthy people using many tax strategies, but over time its reach has spread, especially to people in high-tax states.

Note: Canada also has an AMT for the same purpose, applicable to those who use certain tax strategies.  If often kicks in for those earning a high amount of dividends and no other income.

OTHER CHANGES

Lawmakers permanently reinstated the Personal Exemption Phase-out (PEP) and the “Pease” provision, both of which lapsed in 2010. Both apply to married filers with an adjusted gross income in excess of $300,000 or $250,000 for single filers.

PEP will cut or eliminate the value of deducting personal exemptions for taxpayers above those income thresholds. The Pease provision is a complex limitation on all itemized deductions that will eliminate up to 80% of deductions for taxpayers above the thresholds.

The end result is essentially a higher marginal tax rate for those in the top brackets and is expected to raise $152 billion over the next 10 years.

 

MARKET RECAP (as of January 4th, 2013)

  • The TSX closed at 12541, up 225 points or 1.83% over the past week. YTD the TSX is flat.
  • The DOW closed at 13435, up 497 points or 3.84% over the past week.YTD the DOW is up 2.53%.
  • The S&P closed at 1466, up 64 points or 4.56% over the past week.YTD the S&P is up 2.81%.
  • The Nasdaq closed at 3102, up 142 points or 4.80% over the past week.YTD the Nasdaq is up 0.36%.
  • Gold closed at 1657, changed 0.00 points or 0.00% over the past week.YTD gold is down -1.37%.
  • Oil closed at 93.06, up 2.13 points or 2.34% over the past week.YTD oil is up 0.53%.
  • The USD/CAD closed at 0.9879, down -0.0086 points or -0.86% over the past week.YTD the USD/CAD is up 0.03%.

Sources: Advisor.ca, Financial Post, Globe & Mail, Bloomberg