The tax side of the “Fiscal Cliff” has been averted. The American Taxpayer Relief Act allows the Bush-era tax rates to sunset after 2012 for individuals with incomes over $400,000 and families with incomes over $450,000; permanently “patches” the alternative minimum tax (AMT); revives many now-expired tax extenders, including the research tax credit and the American Opportunity Tax Credit; and provides for a maximum estate tax of 40 percent with a $5 million exclusion. The bill also delays the mandatory across-the-board spending cuts known as sequestration.
The Act is nowhere close to the grand bargain as envisioned by the President and many lawmakers after the November elections. Effectively, it is a stop-gap measure to prevent the onus of the expiration of the Bush-era tax cuts from falling on middle income taxpayers. Congress must still address sequestration. Congress is likely to revisit tax policy and spending cuts when it tackles the expected increase on the nation’s debt limit in February. Slowing the growth of entitlements, such as through a “chained-CPI” is certain to be a controversial topic in upcoming debates.
SUMMARY
The devil is in the details and we are still going through the new law carefully, but here are the major tax provisions:
INDIVIDUALS & FAMILIES
• Individuals with incomes above the $450,000/$400,000 thresholds ($450,000 for joint filers; $425,000 for heads of household) will pay more in taxes because their tax rate rises to 39.6 percent income tax rate and a 20 percent maximum capital gains tax;
• All taxpayers will find less in their paycheck in 2013 because the Act did not extend the 2012 payroll tax holiday that had reduced social security taxes from 6.2 percent to 4.2 percent on earned income up to the wage base ceiling ($113,700 for 2013);
Marriage Penalty Relief
• The Act extends all existing marriage penalty relief;
Permanent AMT Relief
• The new law “patches” the Alternative Minimum Tax (AMT) for 2012 and subsequent years by increasing the exemption amounts and allowing nonrefundable personal credits to the full amount of the individual’s regular tax and AMT. Additionally, the Act provides for an annual inflation adjustment to the exemption amounts for years beginning after 2012. The legislation permanently increases the exemption amounts to $50,600 for single filers, $78,750 for joint filers and $39,375 for married taxpayers filing separately;
Capital Gains/Dividends Sunsets
• Dividends and long-term capital gains are taxed at 20% for individuals making over $400,000 ($450,000 for joint returns);
Personal Exemption Phase-Out
• The personal exemption phase-out is reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 for married taxpayers filing separately. Under the phase-out, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold;
Itemized Deduction Phase-Out
• The itemized deduction phase-out is reinstated with a threshold of $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 for married taxpayers filing separately. Under this phase-out, the total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer’s AGI exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions;
Mortgage Insurance Premiums
• This provision treats mortgage insurance premiums as deductible interest that is qualified residence interest. The Act extends this provision through December 31, 2013.
State and Local Sales Tax Deduction
• The Act extends through 2013 the election to claim an itemized deduction for state and local general sales taxes in lieu of state and local income taxes;
Earned Income Credit
• The Act makes permanent or extends through 2017 enhancements to the earned income credit (EIC) in Bush-era and subsequent legislation.
Child Care Credit
• The Act extends permanently the $1,000 child tax credit. Certain enhancements to the credit under Bush-era legislation and subsequent legislation are also made permanent;
Adoption Credit/Assistance
•The Act extends permanently Bush-era enhancements to the adoption credit and the income exclusion for employer-paid or reimbursed adoption expenses up to $10,000 (indexed for inflation) both for non-special needs adoptions and special needs adoptions;
Child And Dependent Care Credit
• The Act extends permanently Bush-era enhancements to the child and dependent care credit. The current 35 percent credit rate is made permanent along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individual;.
Employer-Provided Child Care Credit
• The Act extends permanently the Bush-era credit for employer-provided child care facilities and services;
American Opportunity Tax Credit
• The Act extends through 2017 the American Opportunity Tax Credit (AOTC). The AOTC is an enhanced, but temporary, version of the permanent HOPE education tax credit;
Deduction For Qualified Tuition And Related Expenses
• The Act extends until December 31, 2013 the above-the-line deduction for qualified tuition and related expenses. The bill also extends the deduction retroactively for the 2012 tax year;
Student Loan Interest Deduction
• The Act extends permanently suspension of the 60-month rule for the $2,500 above-the-line student loan interest deduction. The Act also expands the modified adjusted gross income range for phaseout of the deduction permanently and repeals the restriction that makes voluntary payments of interest nondeductible permanently;
Coverdell Education Savings Accounts
• The Act extends permanently Bush-era enhancements to Coverdell education savings accounts (Coverdell ESAs). These enhancements include a $2,000 maximum contribution amount and treatment of elementary and secondary school expenses as well as postsecondary expenses as qualified expenditures;
Employer-Provided Education Assistance
• The Act extends permanently the exclusion from income and employment taxes of employer-provided education assistance up to $5,250;
Teachers’ Classroom Expense Deduction
• The Act extends through 2013 the teacher’s classroom expense deduction. The deduction, which expired after 2011, allows primary and secondary education professionals to deduct (above-the-line) qualified expenses up to $250 paid out-of-pocket during the year;
Exclusion Of Cancellation Of Indebtedness On Principal Residence
• Cancellation of indebtedness income is includible in income, unless a particular exclusion applies. This provision excludes from income cancellation of mortgage debt on a principal residence of up $2 million. The Act extends the provision for one year, through 2013;
IRA Distributions to Charity
• The new law extends for two years, through December 31, 2013, the provision allowing tax-free distributions from individual retirement accounts to public charities, by individuals age 70 & 1/2 or older, up to a maximum of $100,000 per taxpayer per year;
Energy Credits For Individuals
• The credit is available to individuals who make energy efficiency improvements to their existing residence. The lifetime credit limit is $500 ($200 for windows and skylights) under the 2010 tax bill. The Act extends the credit at the $500 level through December 31, 2013;
ESTATES AND GIFTING
• The Act permanently extends the inflation adjusted $5 million exemption for estate, gift, and generation-skipping transfer tax purposes. The top estate, gift and GST rate is increased from 35% to 40%;
Portability
• The new law makes permanent “portability” between spouses. Under the portability rules, the estate of a decedent who is survived by a spouse can elect to apply any unused exclusion amount to the surviving spouse’s own transfers during life and at death. The portability provision was made permanent by this legislation;
State Death Tax Credit/Deduction
• The Act extends the deduction for state estate taxes;
BUSINESSES
Payroll Taxes
• The payroll tax holiday for the Social Security tax was allowed to expire. Consequently, the employee-share of social security taxes reverts back to 6.2% (from 4.2%);
Bonus Depreciation
• The Act extends 50 percent bonus depreciation through 2013. Some transportation and longer period production property is eligible for 50 percent bonus depreciation through 2014. It now generally applies to property placed in service before January 1, 2014 (January 1, 2015, for certain property with longer production periods);
Section 179 Small Business Expensing
• The Act extends through 2013 enhanced Section 179 small business expensing. The Section 179 dollar limit for tax years 2012 and 2013 is $500,000 with a $2 million investment limit. Before the Act, expensing limit was set at $139,000. The rule allowing off-the shelf computer software is also extended;
Research Tax Credit
• The Act extends through 2013 the research tax credit, which expired after 2011. The incentive rewards taxpayers that engage in qualified research activities with a tax credit;
Work Opportunity Tax Credit
• The Act extends through 2013 the Work Opportunity Tax Credit (WOTC), which rewards employers that hire individuals from targeted groups with a tax credit;
Qualified Leasehold/Retail Improvements, Restaurant Property
• The Act extends through 2013 the 15-year recovery period for qualified leasehold improvements, qualified retail improvements and qualified restaurant property;
Energy tax incentives extended by the Act through 2013, include:
▪ Credit for energy-efficient new homes;
▪ Credit for energy-efficient appliances;
More Business Tax Extenders
A number of other business tax extenders expired after 2011 and they are extended through 2013 under the new law.
They include, among others:
▪ 100 percent exclusion for gain on sale of qualified small business stock;
▪ Reduced recognition period for S corporation built-in gains tax;
▪ Enhanced deduction for charitable contributions of food inventory;
▪ S corporations making charitable donations of property;
Not extended. Certain business provisions were not extended by the Act. These include:
▪ Enhanced deduction for corporate charitable contributions of book inventory;
▪ Enhanced deduction for corporate charitable contributions of computers.
TAX PLANNING
Rest assured as we meet with you to discuss your 2012 taxes, we will outline more specifically how the new tax law will impact you directly. If you have questions, please give us a call at (630) 665-4440.
