The so-called “fiscal cliff”is a name that has been attached to the combination off spending cuts and tax increases at the federal level that are scheduled to take effect at the end of 2012, if Congress fails to reach an agreement to address the federal budget deficit. Both the U.S. Senate and the U.S. House are trying to find a federal budget compromise that can be passed by both houses of Congress, and ultimately signed into law by President Obama. Congress has set up legislation that will allow the automatic tax increases and federal spending reductions to occur, if no budget agreement is reached.
The automatic tax increases that would occur in 2013, if no agreement is reached by Congress, would add approximately $550 billion to the Federal treasury next year. If no budget agreement is reached, the required federal government spending reductions would reduce federal spending by about $109 billion in 2013, which would affect nearly every program that receives federal funding. The combination of the automatic tax increases and required federal spending reductions would essentially cut the federal budget deficit in half from the current level in just one year. However, most national economists agree that if Congress and the president allow the fiscal cliffto occur in the coming weeks, it will likely lead to another recession in the U.S. economy in 2013 and beyond.
The tax increases that would result from reaching the fiscal cliffwould affect most tax paying U.S. citizens, as well as most business of all sizes, including farm operations. Farmers would also be affected by the higher tax rates that would kick-in under the alternative minimum tax. In addition, capital gains taxes are scheduled to have a substantial increase in 2013, if not adjusted. The capital gains tax rate would increase from the current rate of 15% to a 20% rate in 2013 for those in the 25% tax bracket and higher. In addition, there will be a Medicare tax increase of 3.8% on capital gains in some instances, resulting in a final capital gains tax rate of 23.8%.
Another issue affecting farm operators will be changes in the depreciation deduction for capital purchases such as machinery, grain and livestock facilities, tile, etc. The Section 179 expensing limit for accelerated depreciation on Federal tax returns was $500,000 in 2010 and 2011, before dropping back to $139,000 for 2012, and is scheduled to be reduced to $25,000 in 2013, without any adjustments by Congress. Also, the extra 50% bonus depreciation tax deduction that is currently in place is scheduled to expire after 2012.
A major issue that could have a significant impact on farm families is the potential large increases in the estate taxes in 2013 and beyond. The current exemption from paying estate taxes for farm families is $5.1 million per individual, and the current estate tax rate is 35%. The estate tax exemption will drop to $ 1 million/individual in 2013, with a 55% tax rate, without any adjustments by Congress. An estate with a land parcel of 125 acres, valued at $8,000/acre, is worth $1 million, which would hit the new exemption threshold. This change could have a large economic impact on younger farm families that inherit the family farm operation in the future, as they could be required to pay substantial federal estate taxes in order to continue farming.
The spending cuts in the federal budget would be automatic under the “sequestration” agreement approved by Congress and President Obama, as part of a previous federal budget agreement. These federal budget cuts would include defense spending, Medicare, food stamps, education, farm programs and almost every federal program. The spending cuts would be at a pre-set rate of reduction, and would not be prioritized by program, based on need or importance.
Editor’s note: Kent Thiesse is a former University of Minnesota Extension educator and now is Vice President of MinnStar Bank, Lake Crystal, MN. You can contact him at 507-726-2137 or via e-mail at [email protected]