The “fiscal cliff” is over! President Obama signed into law the American Taxpayer Relief Act which permanently extends the Bush-era cuts for lower and moderate income taxpayers and permanently “patches” the alternative minimum tax (AMT), provides for a permanent 40-percent federal estate tax rate, renews many individual, business and energy extenders, and much, much more. In general, it creates important planning opportunities for taxpayers. Following are some of the highlights.
Individual tax Rates: All individual marginal tax rates were retained. A new top rate of 39.6% is imposed on taxable income over $400,000 for single filers, $425,000 for head-of –household files, and $450,000 for married taxpayers filing jointly. See the table below for the projected rate schedule.
Single Individuals:
| If Taxable Income is: | The Tax Will Be: |
| Not over $8,925 | 10% of taxable income |
| Over $8,925 to $36,250 | $892.50 plus 15% of the excess over $8,925 |
| Over $36,250 to $87,850 | $4,991.25 plus 25% of the excess over $36,250 |
| Over $87,850 to $183,250 | $17,891.25 plus 28% of the excess over $87,850 |
| Over $183,250 to $398,350 | $44,603.25 plus 33% of the excess over $183,250 |
| Over $398,350 to $400,000 | $115,586.25 plus 35% of the excess over $398,350 |
| Over $400,000 | $116,163.75 plus 39.6% of the excess over $400,000 |
Married Couples Filing Jointly
| If Taxable Income is: | The Tax Will Be: |
| Not over $17,850 | 10% of taxable income |
| Over $17,850 to $72,500 | $1,785 plus 15% of the excess over $17,850 |
| Over $72,500 to $146,400 | $9,982.5 plus 25% of the excess over $72,500 |
| Over $146,400 to $223,050 | $28,457.5 plus 28% of the excess over $146,400 |
| Over $223,050 to $398,350 | $49,919.5 plus 33% of the excess over $223,050 |
| Over $398,350 to $450,000 | $107,768 plus 35% of the excess over $398,350 |
| Over $450,000 | $125,846 plus 39.6% of the excess over $450,000 |
Capital Gains and dividends:
A 20% rate applies to capital gains and dividends for individuals who are in the 39.6% income tax bracket. The 15% rate still applies to taxpayers below this bracket. The zero rate still applies to taxpayers in the 10% to 15% brackets. Qualified dividends for all taxpayers continue to be taxed at capital gains rates, rather than ordinary income tax rates.
Installment payments received after 2012 are subject to the tax rates for the year of payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later will now be taxed at the 20 percent for higher-income taxpayers.
Permanent Alternative Minimum Tax Relief:
The new act permanently patches the Alternative Minimum Tax 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 amount for years beginning after 2012.
The latest patch immediately saves over 60 million taxpayers from being subject to AMT. The exemption differential for married filing joint taxpayers is a maximum of $8,775 for 2012.
Itemized Deduction and Exemption limitation:
Under the new act the earlier limitation on itemized deductions is brought back with higher “applicable threshold” levels. Now for married couples with income above $300,000 the amount of allowable itemized deductions is reduced by three percent of the amount in excess of the applicable threshold. However, the amount of itemized deductions is not reduced by more than 80 percent and certain items, such as medical expenses, investment interest and casualty, theft or wagering losses, are excluded.
Likewise, the Personal exemptions are phased out at the same “applicable thresholds”.
Payroll Tax Cut: The employee-side payroll tax holiday is not extended. Before 2013, the employee-share of OASDI taxes was reduced by two percentage points from 6.2 to 4.2 percent up to the Social Security wage base. This provision is no longer in effect, which will cost taxpayers up to $2,202 in additional payroll taxes.
Federal Estate, Gift and GST Taxes
The Act permanently provides for a maximum federal estate and gift tax rate of 40 percent with annually inflation-adjusted $5.120 million exclusion for estates of decedents dying after December 31, 2012.
Portability: The Act makes permanent “portability” between spouses. Portability allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent’s unused exclusion to the surviving spouse’s own transfers during life and at death.
Gift Tax Annual Exclusion: the annual exclusion will increase to $14,000 per year per donee.
Transfer Tax Changes that were NOT enacted:
- The Administration had proposed eliminating the differences in income tax and estate tax treatment of “Defective Grantor Trust” by including the assets of the trusts in the Donor’s taxable estate. This is not part of new law.
- The Administration had proposed limiting GST/Dynasty Trusts to a maximum of 90 years. This is not included in the Act.
- The Administration had proposed a minimum 10 year term for Grantor Retained Annuity Trusts. This is not part of the Act.
More Individual Tax Extenders:
Exclusion of Cancellation of Indebtedness on Personal Residence: This provision excludes from income the cancellation of mortgage debt on a principal residence of up to $2M. The provision is extended through 2013.
Mortgage Insurance Premiums: This provision treats mortgage insurance premiums as deductible interest that is qualified residence interest. The provision is extended thru December 31, 2013.
Contribution of Capital Gains real Property for Conservation: The Act extends for two years, through December 31, 2013the special rule for contributions of capital gain real property for conservation purposes. The special rule allows the contribution to be taken against 50 percent of the contribution base.
Tax Free Contributions of IRA Accounts to Public Charities: The provision allows taxpayers 70 ½ and older, to transfer up to $100,000 directly to a public charity. The Act provides special transition rules. The rules allows taxpayers to recharacterize distributions made in January 2013 as made on December 31, 2012 and allows taxpayers to treat a distribution from the IRA to the taxpayer made in December 2012 as a charitable distribution if transferred to charity before February 1, 2013.
Code Section 179 Small Business Expensing: The Code Section 179 dollar limit for tax years 2012 and 2013 is $500,000 with a $2M investment limit. The rule allowing off the self computer software is also extended.
Bonus Depreciation: The Act extends the 50 percent bonus depreciation thru 2013. Bonus depreciation also relates to the vehicle depreciation dollar limits which impose dollar limitations on the depreciation deduction for the year in which a taxpayer places a passenger automobile in service.
Research Tax Credit: The Act extends thru 2013 the research tax credit which would have expired after 2011.
Small Business Stock: To encourage investment in small business, the tax laws in recent years have allowed non-corporate taxpayers to exclude a percentage of the gain realized from the sale or exchange of small business stock held for more than five years. The Act extends the 100-perecnet exclusion from the sale or exchange of small business stock through 2013.
Other Business Extenders:
- Temporary minimum low-income tax credit rate for non-federally subsidized new buildings;
- Housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds.
- Indian employment tax credit;
- New markets tax credit
- Railroad tract maintenance credit
- Mine rescue team training credit
- Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.
- Enhanced charitable deduction for contributions of food inventory;
- Basis adjustment to stock of S corporations making charitable contributions of property;
- Reduction in S corporation recognition period for built-in-gains tax
Foreign Provisions: The withholding tax on gains for the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent and the amount is increased to 20%.
New Taxes that take effect January 1st as a result of the 2010’s health care reform legislation:
Additional hospital insurance tax on high-income taxpayers: The employee portion of the hospital insurance tax portion of FICA, normally 1.45% of covered wages, is increased by .9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both taxpayer and taxpayer’s spouse at a threshold amount of $250,000 for married, $125,000 for married filing separate returns, and $200,000 for any other taxpayer.
Medicare tax on investment income: Starting January 1st individuals will pay 3.8% additional tax on net investment income for the year for income above $250,000 for married individuals, $125,000 for married filing separately, and $125,000 for all other taxpayers. Net investment income means investment income reduced by deductions which are property allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, rents, net gain from disposition of property, and passive income from a trade or business.
Medical care itemized deduction threshold: The threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is not effective for taxpayers who turn 65 during 2013 to 2016 in which case the threshold remains at 7.5%.
Health flexible spending arrangements: Effective for cafeteria plan years beginning after December 31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for the plan year is $2,500.