On January 1st, Congress passed “fiscal cliff” legislation that prevented automatic spending cuts and also extended many tax laws. President Obama signed the American Taxpayer Relief Act of 2012 (the Act). The new law makes permanent Bush-era tax rates for individuals and couples with annual incomes of less than $400,000 and $450,000, respectively. The law also permanently “patches” the alternative minimum tax (AMT), provides changes to the Federal estate tax rate, renews many individual, business and energy tax provisions, and more. However, the Act did not extend the 2012 employee-side payroll tax holiday. Here are the major highlights:
- Income Tax: Starting in 2013, an increase to a top tax rate to 39.6 percent (from 35 percent) for individuals earning more than $400,000 and married couples earning more than $450,000. The rest of the Bush-era income tax rates ranging from 10 percent to 35 percent are made permanent.
- Payroll Tax: The two percent holiday for the employee portion of Social Security taxes (which reduced the tax rate from 6.2 percent to 4.2 percent) will be allowed to expire January 1, 2013.
- Alternative Minimum Tax: A permanent “patch” is put in place to raise the AMT exemptions and prevent more than 30 million taxpayers from being subject to AMT tax in 2012 and beyond.
- Dividends and Capital Gains: For individuals earning income more than $400,000 ($450,000 for married couples), the top tax rate on qualified dividends and long-term capital gains will increase to 20 percent in 2013. Individual taxpayers with income below these thresholds will continue to have qualified dividends and long-term capital gains taxed at 15 percent.
- Federal Estate Tax: The top estate tax will increase to 40 percent (from 35 percent) effective January 1, 2013. The current 2012 gift and estate tax exclusion of $5.12 million (adjusted for inflation) and portability between spouses will continue.
- Bonus depreciation/small business expensing: The new law extends the 2012 allowance for 50 percent bonus depreciation through 2013. Code Section 179 small business depreciation is also extended through 2013 with a $500,000 expensing allowance and a $2 million investment limit. This allowance was scheduled to plummet in 2013 to $25,000 with a $200,000 investment limit.
The new law contains many extenders and other tax relief:
- Deductions: The new law revives the phase-out of itemized deductions and personal exemptions after 2012 for higher income individuals, but at higher income thresholds. The new thresholds after 2012 are $300,000 for married couples and $250,000 for individuals.
- The Act does not include a percentage or hard dollar cap on itemized deductions.
- Child tax credit and related incentives: The $1,000 child tax credit was scheduled to revert to $500 per qualifying child after 2012. The Act makes permanent the $1,000 child tax credit. Along with the child tax credit, the new law makes permanent the enhanced adoption credit/and income exclusion; the enhanced child and dependent care credit and the Bush-era credit for employer-provided child care facilities and services.
- Education incentives: A number of popular education tax incentives are extended or made permanent by the Act. The American Opportunity Tax Credit is extended through 2017. Enhancements to Coverdell education savings accounts, such as the $2,000 maximum contribution, are made permanent. Additionally, the above-the-line higher education tuition deduction is extended through 2013 as is the teachers’ classroom expense deduction.
- Charitable giving: The Act extends a charitable giving incentive through 2013: tax-free IRA distributions to charity by individuals age 70 1/2 and older up to maximum of $100,000 for qualified taxpayer per year. A special transition rule allows individuals to recharacterize IRA distributions made in January 2013 as being made on December 31, 2012. The new law also extends for businesses the enhanced deduction for charitable contributions of food inventory.
- Extenders: A list of individual and business tax incentives and credits are extended through 2013, including:
- Itemized deduction for state and local sales taxes
- 15-year recovery period for qualified leasehold improvements, retail improvements and restaurant property
- Research tax credit
- Work Opportunity Tax Credit
- New Markets Tax Credit
- Tax incentives for empowerment zones
- Energy: The new law extends some energy tax incentives including the credit for homeowners who make energy efficient improvements, a production tax credit for wind energy, credits for biofuels, credits for energy-efficient appliances, and many more.
- Sequestration: Congress and the Obama administration must still tackle sequestration, which the Act only delayed for two months.
In addition to the various tax provisions discussed above, some new taxes also took effect January 1, 2013 as a result of 2010’s health care reform legislation. The new law did not change or modify the proposed Medicare surtax on wages and investment income of high-income taxpayers. An additional 0.9 percent Medicare tax on wages and 3.8 percent Medicare tax on investment income applies to married couples earning more than $250,000 and individuals earning more than $200,000.
Due to the significant changes in the tax law for 2012 and 2013, we expect that most taxpayers will see an impact from the Act both on their 2012 tax returns and in their 2013 tax planning going forward.
If you have any questions about the American Taxpayer Relief Act or the Medicare surtax and how they impact your personal situation, please contact us for additional information and review of your tax issues.