While many Americans were still celebrating the start of a new year, the U.S. Congress passed the American Taxpayer Relief Act of 2012 on January 1 to avert the tax side of the so-called fiscal cliff. President Obama signed the bill into law on January 2. Notwithstanding the fact that the 2012 bill was passed in 2013, the Act has many important tax components that take effect in 2013 and others that are retroactive to the beginning of 2012. We will attempt to sort it out for you in a concise manner below, but we invite you to call any of our tax team members for more details and to specifically address your situation.
Ordinary Income Tax Rates: For a vast majority of Americans, the income tax rates for 2013 will be the same as 2012. However, for those with taxable income of over $400,000 ($450,000 for joint filers; $425,000 for heads of households), the tax rate for ordinary income over those thresholds will be taxed at 39.6% rather than 35%.
Note that for trusts and estates, the highest 39.6% rate will apply for taxable income in excess of $11,950.
Capital Gains/Dividends Tax Rates: For taxpayers above the same $400,000/$425,000/$450,000 thresholds noted above, the top federal rate for long-term capital gains and qualified dividends will be 20% in 2013 versus 15% in 2012. For those under these thresholds, the current 2012 tax rates apply.
Note that the 25% tax rate for certain real estate gains and the 28% tax rate for sales of collectibles were not changed under the new law.
Keep in mind that installment payments received on prior sales are generally taxed in the year of receipt at the prevailing rates. Therefore, installment payments received in 2013 will generally be subject to the 20% rate for those taxpayers with income in excess of the thresholds noted above.
The Hidden Tax Increase: Limitation on Itemized Deductions and Exemptions: Recall that prior to the “Bush-era” tax rates, high income taxpayers had to reduce certain otherwise allowable itemized deductions by 3% of the amount by which their adjusted gross income (AGI) exceeded an applicable threshold. They also had their personal exemptions phased out by 2% for each $2,500 of AGI in excess of an applicable threshold. These limitations are back beginning in 2013 but at higher AGI thresholds: $300k for joint filers, $275k for heads of households and $250k for singles. For those affected, this is a hidden tax increase. The prior law capping the reduction of itemized deductions to 80% was retained in the law.
Alternative Minimum Tax (AMT) Changes: In order to prevent an estimated 60 million taxpayers from having to pay AMT for 2012 and beyond, the AMT exemptions have been increased under the Act to similar levels in effect prior to 2012. The exemptions will be adjusted annually for inflation going forward. Still, these changes will not keep many of our clients who have historically had to pay AMT from continuing this ritual.
Individual Tax Extenders: The Act extended over 30 tax provisions retroactive to 2012. For individuals, this included (among others):
- Child Tax Credit – $1,000. Phase outs still apply for those with AGI beginning at $75k ($110k for joint filers).
- Child and Dependent Care Credit – Up to $1,200 for joint filers with AGI in excess of $43k and two or more dependents with qualifying dependent care expenses incurred so both spouses can work.
- American Opportunity Tax Credit – Up to $2,500 for qualifying college expenses. Phase outs still apply for those with AGI beginning at $80k ($160k for joint filers).
- Tuition Deduction – In lieu of the American Opportunity Tax Credit, an “above-the-line” deduction of up to $4,000 can be taken by those with AGI of less than $65k ($130k for joint filers) and $2,000 for those with AGI exceeding $65k but less than $80k (160k for joint filers).
- Exclusion of Cancellation of Mortgage Debt – Through 2013, cancellation of debt income is not taxable if the debt relief is attributable to one’s principal residence and is less than $2 million.
- IRA Distributions for Charity – Up to $100k of IRA distributions can be excluded from income for those older than 70-1/2 if transferred directly to public charities.
- State and Local Sales Tax Deduction – In lieu of deducting state income taxes, taxpayers can deduct sales taxes which generally will only benefit our clients residing in states with no state income tax (for example Florida and Tennessee).
- Energy Credits – Up to $500 lifetime credit for energy improvements made to existing residences ($200 for windows and skylights).
Estate and Gift Tax Changes: The $5 million estate and gift tax exclusion (adjusted for inflation) was retained by the Act. Also, the Act extended the “portability” provisions previously in place whereby the unused exclusion from a deceased spouse can be transferred to the surviving spouse. The downside is that the maximum tax rate was increased to 40% from 35%.
While we recognize many of our high net worth clients rushed to make gifts via trusts (if not outright) in 2012 given the fear that the exclusion could go down to $1 million or $3.5 million in 2013, such moves should still prove sound for most since future appreciation of the gifted assets will also escape estate tax and the trusts should provide creditor protection.
Depreciation Provisions: It is a little too late to plan for 2012, but the Section 179 expensing deduction for certain fixed asset acquisitions has been increased to $500k for 2012 and 2013, subject to a $2 million investment limit. The Act extends the 50% bonus depreciation through 2013. The Act also extends through 2013 the provision that allows a shortened 15-year depreciation life for qualified leasehold improvements, retail improvements and restaurant property.
Business Tax Extenders: Many business tax provisions had expired after 2011 but now have been extended for 2012 through 2013:
- Research Tax Credit
- Certain energy tax incentives
- Opportunity Tax Credit
- New Markets Tax Credit
- One hundred percent exclusion for gain on sale of qualified small business stock
- Reduced recognition period to 5 years for S corporation built-in gains tax
- Special expensing rules for qualified film and television productions
- Tax incentives for empowerment zones
Other Items To Note:
- Payroll Taxes – The temporary 2% payroll tax cut in effect in 2012 was not extended for 2013 so every employee will see an increase in their taxes. In addition, for earned income in excess of $200,000 ($250,000 joint filers), the Medicare tax will be raised .9% from 1.45% to 2.35%. Self-employment tax will correspondingly increase by .9%.
- Medicare Surtax on Investment Income – The Act did not make any changes to the Patient Protection and Affordable Care Act of 2010, so investment income will be subject to a new 3.8% Medicare tax in 2013 for those with AGI of $200,000 ($250,000 joint filers) on top of the increased rates noted above.
- Annual Gift Exclusion – The amount a taxpayer can give a gift recipient on an annual basis without impacting gift taxes or the lifetime exclusion will be $14,000 in 2013 up from $13,000.
No Rest For The Weary: The Act mostly just addressed taxes. The “new” Congress now must address other issues that the “old” Congress postponed, such as federal spending cuts. Unless they act by March 1, automatic cuts are set to impact nearly all federal agencies, with half the money coming out of the military. While everyone seems to agree that spending cuts are necessary, the impending automatic cuts would prevent Congress from exercising more control over where those cuts should be taken.
In addition, Congress needs to address debt ceiling issues. It is estimated that by late February or early March the federal government will have reached its $16.4 trillion limit on borrowing. This and other issues could cause a government shutdown during 2013 absent an agreement.
And many in Congress say they are interested in major tax reform during 2013. The debate has already started on what it would look like and whether such reform should be revenue neutral or a revenue raiser. If the latter, you can bet that many of our clients will be greatly affected.
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If you have any questions about any of the provisions in the Act or would like to discuss your specific situation, please contact us. See also our earlier tax briefs at www.wblcpa.com. In the meantime, we will continue to monitor the activity in Washington for you and report back as warranted.