How the cliff act affects cross-border taxes

By Terry F. Ritchie | January 8, 2013 | Last updated on September 15, 2023
3 min read

Going over the fiscal cliff would have meant significant increases in Americans’ U.S. income and estate tax exposure.

Fortunately for your American in Canada and snowbird clients, the U.S. passed The American Taxpayer Relief Act last week.

Read: Fiscal cliff could raise cross-border taxes

Although we know the U.S. income, gift and estate tax rates for the next few years, it will be even more critical to know the different income tax implications when managing portfolios for American in Canada clients. This is because U.S. income tax rates on dividends and short- and long-term capital gain rates could rise.

Here’s an overview of the income tax changes.

Tax rates

The new legislation now permanently extends the Bush tax cuts for most U.S. taxpayers. Now, people who make less than $400,000 and married couples who make less than $450,000 will be taxed under the previous U.S. rates (10%, 15%, 25%, 28%, 33% and 35%). They will have a new top rate of 39.6%.

Read: Cliff averted, but confrontation looms

Capital gains and dividends

Effective this year, the maximum capital gains tax rate will increase from 15% to 20% for taxable incomes over $400,000 ($450,000 for married couples filing jointly).

Keep in mind the additional 5% long-term capital gain rate will only apply when the gain, in addition to other taxable income, exceeds the threshold amounts.

Dividends will now be taxed at ordinary marginal rates to the extent taxpayers exceed the thresholds above. So, if a single individual had taxable income less than $400,000, she would have a 15% rate as opposed to the higher rates that were previously proposed (see Fiscal cliff could raise cross-border taxes and the related example).

Medicare tax on investment income (a.k.a. Obamacare surtax)

There’s now a 3.8% Medicare surtax on capital gains and other net investment income (interest, dividends, annuities, royalties, rents and income from trade or business interests). This new rate will be imposed on people with taxable incomes greater than $200,000 and married couples with taxable incomes greater than $250,000.

Read: Goldman execs skirt higher cliff taxes

Because the income threshold is lower than the 39.6% top tax rate threshold, the surtax would apply to the respective taxpayer’s ordinary and net capital gains rate.

US Individual Income Tax Rates for 2013

Taxable Income * Ordinary Capital Gains Medicare Tax
Single Joint Income & Dividends Earned Investment
Income ** Income
$0+ $0+ 10% 0%
$8,950+ $17.900+ 15%
$36,250+ $72,500+ 25% 2.90% 0%
$87,850+ $146,400+ 28%
$183,250+ $223,050+ 33% 15%
$200,000+ (AGI) $250,000+ (AGI)
$398,350+ $398,350+ 35% 3.80% 3.80%
$400,000+ $450,000+ 39.60% 20%
* Based on estimated 2013 inflation adjustments. Amounts refer to taxable income except where noted
** Combined rate includes 1.45% employer contribution

Deductions and personal exemption limitations

Itemized deductions and personal exemptions will be phased out for certain taxpayers, so being proactive will be critical. The phase-outs will apply to taxpayers with adjusted gross incomes (AGI) of $250,000 (Single) and $300,000 (Married Joint).

These provisions will reduce or eliminate the benefit of the personal exemption for high-income earners and greatly reduce the ability of high-income taxpayers to make certain deductions (primarily mortgage interest; real estate taxes; state and local income taxes; charitable contributions; and limited medical deductions).

Alternative minimum tax (AMT)

For those of you who work with Americans in Canada, this dastardly tax often rears its ugly head. The AMT is now permanent and will be adjusted for inflation in future.

Read: Help clients avoid tax surprises

Terry F. Ritchie