The New Year's fiscal cliff compromise averted the perfect storm anticipated by economists with a mixed-bag approach. Lawmakers addressed expiring tax provisions, emergency unemployment benefits, and reductions in Medicare physician payments, but postponed action on sequestration and raising the federal debt ceiling. Passage of the American Taxpayer Relief Act of 2012 (H.R. 8) seems to have temporarily soothed the financial markets, however another Capitol Hill showdown is expected as automatic across-the-board spending cuts loom, as does the possibility of the U.S. defaulting on its debts.
The agreement extends numerous tax provisions that had been set to expire, including a number of NACUBO priorities, such as the American Opportunity Tax Credit, Section 127, and the IRA Charitable Rollover, which are described in greater detail below. The success in protecting these important programs is due in no small part to the NACUBO members who weighed in with Washington policymakers over the past year to bring attention to higher education-related tax and budgetary concerns.
H.R. 8 extends Bush-era income rates for taxable income up to $400,000 for individuals and $450,000 for couples — but allows tax rates to rise from 35 percent to 39.6 percent on higher level incomes. The legislation also increases tax rates for capital gains and dividends on such income from 15 percent to 20 percent, and increases the estate tax from 35 percent to 40 percent. It also includes a permanent "patch" for the alternative minimum tax.
The deal extended unemployment insurance and halted a scheduled cut in Medicare physician payments, but it did not extend the 2009-2011 2 percent payroll tax "holiday."
Reinstatement of Limitations on Deductions
Lawmakers did not include any new limitations on personal deductions or exemptions, but they did reinstate two previously existing limitations: the limitation on itemized deductions, and the personal exemption phase out, respectively known as "Pease" and "PEP." These limitations impact taxpayers with adjusted gross incomes over $250,000 for individuals and $300,000 for joint filers.
As budget talks continue, NACUBO remains concerned about the possibility of further limitations, particularly to the charitable deduction. Given the federal deficit situation, legislators are likely to consider various spending cuts as well as new revenue sources. Among the ideas that have been offered is a proposal to limit itemized deductions, including the tax deduction for charitable donations. Some have proposed eliminating or limiting tax-exempt interest for municipal bonds. On January 2, Politico reported that while rates are no longer under consideration, "Democrats will need alternative sources of revenue [in the budget battles ahead]. They say they're moving their focus to money that can be gained by closing so-called loopholes in the tax code and limiting the amount that can be claimed in deductions — provisions that tend to benefit top earners disproportionately."
Major Federal Budget Cuts Still Loom
The New Year's measure focused largely on tax revenue and did not address major federal spending questions. Lawmakers simply postponed for two months the onset of sequestration-the across-the-board spending cuts scheduled to begin January 1, 2013 for both defense and non-defense federal programs. Under current law, the Pell Grant, among a select few programs with special treatment, is protected for one year from sequester cuts. According to a report released by the White House Office of Management and Budget (OMB) on September 14, by and large all other federal student aid programs would be cut between 7.6 - 8.2 percent. Federal budgets that support academic research and development, such as the National Institutes of Health, National Science Foundation, and Department of Energy, would see an 8.2 percent reduction, but defense research would be subject to a 9.4 percent reduction. Federal subsidy payments for Build America Bonds would also be cut under the sequestration process.
As the 113th Congress attempts to deal with the sequester dilemma, they will need to complete the federal Fiscal Year 2013 budget, which funds federal government operations from October 1, 2012, to September 30, 2013. Presently, the federal government is operating on a continuing resolution that expires on March 27, 2013. The measure generally funds government programs at their FY12 levels for only the first six months of FY13.
Technically, the U.S. Treasury again reached the statutory debt limit on December 31, 2012. Treasury actions to delay default can provide approximately two months in "headroom," which makes it likely that the debt ceiling and sequestration, as well as the final FY13 budget, will be dealt with in a single measure in late February.
Key Higher Education Provisions in H.R. 8
- The American Opportunity Tax Credit (AOTC), which had been scheduled to revert to the less generous Hope Scholarship at the end of 2012, has been extended for five years. The AOTC provides a 100 percent tax credit for the first $2,000 of certain higher education expenses and a 25 percent tax credit for the next $2,000 of such expenses. The AOTC is partially refundable and is available for up to four years of college. It is phased out beginning at $80,000 for single filers and $160,000 for joint filers. According to the Joint Committee on Taxation, this provision would reduce revenues by $53.1 billion and increase outlays by $14.1 billion over ten years.
- Employer-Provided Educational Assistance (Sec. 127) benefits, which were set to expire on December 31, 2012, have been made a permanent part of the U.S. tax code. Sec. 127 allows an employer to offer an employee up to $5,250 per year in tax-free educational assistance for undergraduate or graduate-level courses. This benefit covers tuition, fees, books, supplies, and equipment. This provision is estimated to cost $11.477 billion over ten years.
- The expanded student loan interest deduction (SLID) has also been made permanent. Certain individuals who have paid interest on qualified education loans may claim an above-the-line deduction of up to $2,500 for such interest expenses. Prior to 2001, this benefit was only allowed for 60 months and had lower income thresholds. The bill makes permanent the income phase-out at $70,000 ($110,000 and $140,000 for joint filers). This provision is estimated to cost $9.676 billion over ten years.
- The bill permanently extends expanded Coverdell Education Savings Accounts (ESAs). A Coverdell ESA is an account that allows parents and students to save for education expenses. While the contributions to a Coverdell ESA are not deductible, the amounts deposited grow tax free until distributed. The student will not owe taxes on the distributions if they are less than the student's qualified educational expenses. If the provision had not been extended, Coverdell ESAs would have reverted from allowing annual contributions of up to $2,000 to only $500 on January 1. This provision is estimated to cost $271 million over ten years.
- The above-the-line tuition deduction for qualified tuition and related expenses has been extended for one year, to the end of 2013. This deduction enables taxpayers with a modified adjusted gross income of $65,000 or less a year ($130,000 for married couples filing jointly) to deduct up to $4,000 annually in tuition and related expenses. Individuals with a modified adjusted gross income of more than $65,000 but not more than $80,000 (more than $130,000 but not more than $160,000 for married couples filing jointly) are eligible for an annual deduction of up to $2,000. This provision is estimated to cost $1.706 billion over ten years.
- The Individual Retirement Account (IRA) charitable rollover has been extended through December 31, 2013. Individuals are also allowed to make a rollover during January of 2013 for retroactive 2012 tax purposes. The IRA charitable rollover allows individuals 70½ and older to donate up to $100,000 from their IRAs and Roth IRAs to public charities, including colleges and universities, without having to count the distributions as taxable income. The IRA rollover provision had expired on December 31, 2011. This provision is estimated to cost $1.280 billion over ten years.