Congress approved a bipartisan agreement to reverse spending cuts and tax hikes slated to take effect this year, a day after the United States technically went over the fiscal cliff.

As of January 1, 2013, some $600 billion in federal spending cuts and tax hikes were scheduled to take effect, mandated by the Budget Control Act of 2011. More than two hours after the deadline, the Senate voted 89-8 to support a compromise agreement and the House followed suit on New Year’s Day with a 257-167 vote in support of the package.

According to the deal:

  • The Bush-era tax cuts expire for individuals earning more than $400,000 and married couples earning more than $450,000
  • The top tax rate is raised to 39.6% from 35%
  • The lower tax rates remain for those earning less than the threshold
  • The dividend and capital gains tax rates rise to 20% from 15% for individuals earning more than $400,000 and married couples earnings more than $450,000 (the maximum tax rate on capital gains and dividends will be 23.8% once the new Medicare investment income surtax is included)
  • A permanent fix is included for the alternative minimum tax. The bill increases the exemption amounts for 2012 to $50,600 (individuals) and $78,750 (married filing jointly), and indexes the exemption thereafter
  • The estate tax rate will rise to 40% from 35%, with a $5 million individual exemption (these figures apply to the federal gift tax as well)
  • Income phase-outs for itemized deductions (i.e., Pease limitation) and personal exemptions (i.e., Personal Exemption Phaseout) return beginning tax year 2013. Taxpayers with income over $250,000 ($300,000 for couples) will begin to see the tax benefit of their itemized deductions and personal exemptions reduced
  • Federal spending cuts set to begin January 1, 2013, as part of the sequestration process, will be delayed for two months
  • A number of existing provisions around itemized deductions are extended such as the American Opportunity Tax Credit, which provides tax relief for families paying for college education.

    The Social Security payroll tax on employees will revert back to its previous rate, and rise 2% (from 4.2% to 6.2%) for all workers. In addition, the bill extends unemployment benefits for some two million Americans through the end of 2013.

    In the area of revenue, the Act expands previous legislation allowing workers to transfer existing 401(k) assets into designated Roth accounts (i.e., Roth 401(k)) inside the plan, triggering an event that is taxable as regular income.

    The bill, however, does not resolve the issue of federal spending cuts or the debt ceiling, which will likely have to be addressed sometime in February.