American Taxpayer Relief Act of 2012
“A politician needs the ability to foretell what is going to happen tomorrow, next week, next month, and next year, and to have the ability afterwards to explain why it didn’t happen.”
― Winston S. Churchill
During the last month the role of soothsayer has been awkwardly worn by taxpayers, tax professionals, attorneys, and yes, politicians, as the President and members of Congress have grappled closer and closer against flinging the entire country off the “fiscal cliff”. This term “fiscal cliff” has become common vernacular as many side-bets were placed that an agreement would not be reached until after December 31st. Late January 1st Congress passed the “American Taxpayer Relief Act of 2012” (ATRA) that President Obama then signed into law on January 2nd.
Such year-end theatrics have become an annual occurrence since the legislation commonly referred to as the “Bush tax cuts” were originally scheduled to sunset in 2010. Since then the tax code has limped forward each year with patches and short extensions, speculations, and uncertainty regarding tax planning and what to expect in future years.
Coupled with Congressional disagreement surrounding the Nation’s debt ceiling and an across-the-board governmental discretionary spending cut known as “sequestration”, the tax legislation and extensions that were passed with ATRA were surprisingly more comprehensive than the basic package President Obama hinted at.
Sifting through all of the rhetoric, the bottom line is that concessions were made by parties on both sides of the tax debate and taxes are going up for everyone with an expected larger burden shifting to “America’s Wealthiest Taxpayers”.
ATRA is a mixed-bag that contains both “permanent” and one to five year extenders affecting the tax code.
The most broad-sweeping effect of ATRA that will be felt immediately by all individual taxpayers is the end of the social security tax “holiday” that reduced social security tax from 6.2% to 4.2% on applicable wages. As part of an earlier economic stimulus package, employees have seen an increase in their take-home pay (up to threshold amounts) by 2% since 2010. Along with the increased maximum social security taxable income of $113,700, taxpayers earning at and above this amount will now see a reduction of about $2,425 in take-home pay in 2013. This impacts not only taxpayers with W-2 income, but Schedule C taxpayers as well as materially participating LLP and LLC members who receive ordinary income.
One of the issues that stalled deliberations between Congress and the President regarded the definition of “Wealthiest Taxpayers”. Although the “Patient Protection and Affordable Care Act” (PPACA) will impose a 3.8% additional tax on Net Investment Income for income over $200,000 for single filers, $250,000 for joint filers and surviving spouses and $125,000 for married taxpayers filing separately, concessions were made regarding the new tax rates for 2013. ATRA maintained the previous lower tax brackets with income taxed at 35% on income thresholds as follows:
- $398,350 – $400,000 for single filers
- $398,350 – $425,000 for head of household
- $398,350 – $450,000 for joint filers and surviving spouses
- $199,175 – $225,000 for married filing separately
- The new 39.6% rate is taxed on income above these amounts
Capital gains and Qualified Dividend rates on income exceeding these threshold amounts will now be taxed at a 20% rate with income below the threshold taxed at the previous 15% rate. Taxpayers that fall below the 25% tax bracket will continue to enjoy a 0% tax rate. Planning Point – the 20% rate is still an advantageous rate as compared to the highest ordinary tax rate of 39.6%. Note that under President Reagan in 1986 the long-term capital gains rate was raised to 28% from a rate of 20%.
The AMT exemption has now been permanently adjusted retroactively to 2012, to $50,600 for single taxpayers and $78,750 for married filing joint taxpayers. The exemption will be adjusted for inflation yearly beginning post-2012.
Limitations and phase-out of itemized deductions, also known as the “Pease Limitation” was reinstated with inflation modifications. The limitation reduces itemized deductions by 3% of the amount by which the taxpayer’s adjusted gross income is as follows:
- $250,000 for single filers
- $275,000 for head of household
- $300,000 for joint filers and surviving spouses
- $150,000 for married filing separately
Medical expenses, investment interest, and casualty, theft, or gambling losses are excluded from the limitation and the total reduction cannot exceed 80%.
Previous marriage penalty relief has been extended although some might argue that a stiffer marriage penalty has been imposed for wealthier taxpayers making over $250,000.
Other long-term extensions:
- Earned Income Credit permanently extended
- Adoption Credit/Assistance permanently extended
- Child and Dependent Care Credit permanently extended
- American Opportunity Tax Credit extended through 2017
- Coverdell Education Savings enhancements permanently extended
The following have been extended only through 2013:
- Discharge of qualified principal residence exclusion
- $250 above-the-line teacher expenses deduction
- Mortgage insurance premiums treated as residence interest
- Deduction for state and local taxes
- Above-the-line deduction for tuition
- IRA distributions to charity (with transfers made in January 2013 treated as being made in 2012). Planning point – taxpayers may wish to recharacterize distributions made to a charity in January 2013 as made on December 31, 2012.
With all of the attention on wealthy Americans and the perception of what constitutes their “fair-share” of taxes to be paid being used as political platforms, many temporary tax extenders that favor small businesses have been extended through 2013. These opportunities can affect flow-through income to individual taxpayers as well as influence entity selection as the top rates for C Corporations remain at 35%.
Most notable ATRA extensions include:
- Dollar limitation on Section 179 expensing of $500,000 with a $2,000,000 investment limit for 2012 and 2013
- Bonus Depreciation of 50% on qualified purchases through 2013
- Research and Development Credit modified and extended through 2013
- Hiring and Employment credits extended through 2013
- 15- year recovery period for qualified leasehold improvements, qualified retail improvements, and qualified restaurant property extended through
- Reduction in recognition period for S Corporation built-in gains tax
- Empowerment Zone tax incentives extended through 2013
ESTATE AND GIFT
ATRA permanently instituted a maximum federal estate tax rate of 40% with a $5,000,000 exclusion for estates of decedents dying after 2012 and on unified estate and gift transfers. The exclusion will be adjusted annually for inflation. This concession came as a surprise as most commentators expected to see the rates/amounts to align with thePresident’s position of a maximum 45% rate with a $3,500,000 exemption. It is hard to say whether these favorable estate levels will indeed be permanent or whether estate taxes will again be a bargaining chip in future negotiations.
Portability is permanently extended which allows a surviving spouse to make an election to allow the decedent’s unused exclusion to be applied to the surviving spouse’s own transfers.
These highlights of the new American Tax Relief Act, though coming too late for the tax planning season, provides for changes that affect taxpayers across the board. Though much of the legislation broadly does not come as a surprise, the result is much better than what would have happened if no agreement was reached or delayed further into the New Year.
The quote by Winston Churchill may prove prophetic in more ways than one in that although language such as “permanent” are used throughout the legislation, many feel that the tax code and possibly the inflation index will once again be put on the bargaining table. This could occur as early as this February when the discretionary spending cuts and debt-ceiling debate will be once again be deliberated.
We wanted to share with each of our clients the major highlights of the American Taxpayer Relief Act which are contained above. A slightly more comprehensive version will be forwarded to you in the coming weeks.
We at Rose, Snyder and Jacobs LLP have been actively planning with our clients given the many uncertainties of the tax law. We will continue to issue updates with tax law developments and advise on planning opportunities that may pertain to our clients’ unique situations.
Please do not hesitate to call us with any questions.
Rose, Snyder and Jacobs LLP