After furious round-the-clock year end negotiations, lawmakers determined to act before the U.S. stock markets opened after the New Year’s holiday, passed the American Taxpayer Relief Act of 2012 (the Act.) This legislation, which President Obama promised to sign, averts the dire consequences from the so-called “fiscal cliff” of expiring Bush-era tax cuts and the imposition of spending cuts enacted within other legislation.
The uncertainty of the tax law impeded the long-term tax and cash flow planning for businesses and prevented taxpayers from making informed decisions. With some modifications, the Act extends the Bush-era tax cuts for individuals earning under $400,000 annually and $450,000 for couples, sets the estate tax rate at 40 percent, with an exemption for estates valued under $5 million, provides a permanent patch for the alternative minimum tax (AMT), and taxes dividends and capital gains at 20 percent for individuals earning over $400,000 and couples with income over $450,000.
In addition, the Act extends the Research and Experimentation credit through 2013 and makes permanent certain personal tax credits, such as the child care and college tuition credit and also The Earned Income Tax Credit is extended for five years. The legislation also extends long-term unemployment insurance benefits through 2013, providing a much needed lifeline to about 2 million unemployed Americans.
While many tax provisions were addressed, the Act does not fully resolve the nontax portion of the fiscal cliff regarding automatic spending cuts (“sequestration”) which are now deferred for the next two months. Discussions regarding the growth of the national debt are expected to begin again when the new Congress is sworn in during January. Taxes are likely to continue to be part of the negotiations concerning the national debt over the next few months. While this Act is projected to raise $620 billion over the next ten years, lawmakers are looking for cuts to entitlements to generate $1 trillion in new revenue.
Highlights of the major provisions of the Act include:
- Make the 2001 and 2003 tax cuts permanent for income under $400,000 (single) and $450,000 (joint),
- Return the top rates to 39.6% for ordinary income and 20% for capital gains and dividends (not including the new 3.8% Medicare tax),
- Reinstate the phaseouts for personal exemptions and itemized deductions at income levels of $250,000 (single) and $300,000 (joint),
- Make the $5 million estate and gift tax exemption permanent (indexed for inflation) but raise the rate from 35% to 40%,
- Permanently index the alternative minimum tax (AMT) for inflation,
- Retroactively extend tax provisions such as the research credit,
- Provides 50% bonus depreciation for qualified property placed in service,
- The Act does not extend the 2% point cut in payroll and self employment taxes and,
- It does not repeal any newly effective Medicare taxes.
For many wealthier individuals, taxes will increase due to new taxes, rate increases, and new thresholds in 2013. The Act provides rate cuts for only taxable income under $400,000 for single filers, $425,000 for heads of households and $450,000 for joint filers. Above these thresholds, the rate on ordinary income increases from 35% to 39.6%, and the rate on dividends and capital gains increases from 15% to 20%.
The Act also reinstates the personal exemption phaseout and the phaseout of itemized deductions (“Pease limitation”) on adjusted gross income in excess of $250,000 (single), $275,000 (head of household) and $300,000 (joint). (These phaseouts were eliminated for all taxpayers from 2010 through 2012.) The Pease limitation reduces the total amount of a higher income taxpayer’s allowable itemized deductions by 3% over an applicable threshold. However, itemized deductions are not reduced by more than 80%, and certain items, such as medical expenses, casualty and investment interest are excluded.
The new 3.8% Medicare tax on investment income and 0.9% tax increase on earned income will apply to individuals with adjusted gross income levels of $200,000 (single) and $250,000 (joint). The following chart summarizes 2013 applicable tax rates.
|INDIVIDUAL INCOME TAX RATES FOR 2013|
The capital gain tax rates for high income taxpayers return to what they were under President Clinton, 20 percent. Counting the 3.8% surcharge from the Affordable Care Act, dividends and capital gains will be taxed at 23.8% for these individuals.
The Act also extends all existing marriage penalty relief regarding standard deductions and the increased range of the 15% bracket.
The Act increases the AMT exemptions for 2012 and permanently indexes them for inflation. Prior to this Act, the AMT was never indexed for inflation, so annually, lawmakers had to enact a “patch” to increase the exemption. The 2012 figures below reflect a slight increase over the 2011 exemption amounts and will be the basis for future inflation adjustments.
The Act provides that all non-refundable credits are allowed to the full extent of a taxpayer’s regular and AMT liability for tax years after 2011.
The Act also extends many individual tax provisions through 2013, most of which expired at the end of 2011:
- Deduction for certain expenses of elementary and secondary school teachers;
- Exclusion from gross income of discharge of qualified principal residence indebtedness;
- Parity for exclusion from income for employer-provided mass transit and parking benefits;
- Mortgage insurance premiums treated as qualified residence interest;
- Deduction of state and local general sales taxes;
- Special rule for contributions of capital gain real property made for conservation purposes;
- Extends expansions of the Child Tax Credit, Dependent Care Credit, Earned Income Tax Credit and American Opportunity Tax Credit;
- Above-the-line deduction for qualified tuition and related expenses and extends the student loan interest deduction; and
- Tax-free distributions from individual retirement plans for charitable purposes.
Certain provisions are now permanently extended and include:
- Adoption Credit;
- Exclusion for employer provided educational assistance;
- Coverdell Education Savings Accounts;
Estate and Gift Tax Provisions
The Act generally makes permanent the estate, gift and generation-skipping transfer (GST) tax rules for 2011 and 2012 but increases the top unified rate to 40%. The new rules generally provide:
- Reunification of estate and gift taxes with a 40% rate and $5 million exemption adjusted for inflation (reached $5.12 million in 2012.) The 2013 exemption amount (as indexed for inflation) is expected to be $5,250,000, which reflects an increase of $130,000 over the 2012 exemption amount. The 40% rate applies over the exemption amount,
- Identical rates and exemption for Generation Skipping Transfer tax,
- Portability of estate tax exemption amounts between spouses, and
- Extends the deduction for state death taxes.
The Act also extends many popular business tax credits and other provisions. Most notably, it modifies and extends through 2013 the Credit for Increasing Research and Development activities, which expired at the end of 2011. (The credit computation rules will be modified for taxpayers under common control or for businesses that have changed hands.) The President has called for making this credit permanent, however, this is a costly program so that is sure to be an obstacle.
The increased expensing amounts under Section 179 are extended through 2013. The Sec 179 dollar limit for tax years 2012 and 2013 is $500,000 with a $2 million investment limit. (There are minor changes to related entity rules and Section 179 passed earlier in 2012, which may affect the allowable deduction use among commonly owned entities.) The decrease in the value of this deduction has been postponed until after 2013.
Bonus depreciation has been used as an economic stimulus in recent years. The availability of the additional 50% first-year bonus depreciation was also extended for one year by the Act. It now generally applies to property placed in service before January 1, 2014. To be eligible for bonus depreciation, the property must be new and have a recovery period of 20 years or less. In lieu of bonus depreciation, the Act also extends provisions which allow the ability to claim unused AMT credits rather than take advantage of bonus depreciation.
Other business provisions are extended through 2013, as they originally existed, while some are modified including:
- 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 track maintenance credit;
- Mine rescue team training credit;
- Employer wage credit for employees who are active duty members of the uniformed services;
- Work opportunity tax credit;
- Qualified zone academy bonds;
- Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements;
- Accelerated depreciation for business property on an Indian reservation;
- Enhanced charitable deduction for contributions of food inventory;
- Election to expense mine safety equipment;
- Special expensing rules for certain film and television productions;
- Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico;
- Treatment of certain dividends of regulated investment companies ;
- Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Act;
- Extension of subpart F exception for active financing income;
- Look through treatment of payments between related controlled foreign corporations under foreign personal holding company rules;
- Temporary exclusion of 100% of gain on certain small business stock;
- Basis adjustment to stock of S corporations making charitable contributions of property;
- Reduction in S corporation recognition period for built-in gains tax (remains at 5 years);
- Empowerment Zone tax incentives;
- Tax-exempt financing for New York Liberty Zone;
- Temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands and
- American Samoa economic development credit.
Energy Tax Provisions
The Act extends a number of energy credits and provisions that expired at the end of 2011. Many of the credits and incentives are business related but the Act extended Section 25C, the non business energy property tax credit. The 25C credit is available to individuals who make energy efficient improvements to their existing residence. The lifetime credit limit is $500 ($200 for windows and skylights.) This credit is extended to December 31, 2013.
The Act also extends the Production Credit (Section 45d) for facilities that produce energy from wind facilities. The Act reforms and extends for two years a 10% credit for individuals for highway capable plug in motorcycles and other vehicles.
Other energy incentives extended to December 31, 2013 include:
- Credit for alternative fuel vehicle refueling property;
- Cellulosic biofuel producer credit;
- Incentives for biodiesel and renewable diesel;
- Credits with respect to facilities producing energy from certain renewable resources (eligible businesses can take a 30% credit or a production credit for electricity produced);
- Credit for construction of energy-efficient new homes;
- Credit for manufacturers of energy-efficient appliances;
- Special allowance for cellulosic biofuel plant property,
- Special rule for sales or dispositions to implement Federal Energy
- Regulatory Commission or state electric restructuring policy for qualified electric utilities and
- Alternative fuels excise tax credits.
The Act adopted a number of extenders affecting both inbound investments and US Cross border transactions.
- Application of a withholding tax to gains on 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%.
- Extension of Subpart F exceptions for active financing income. Exemptions exist for certain insurance income and active financing income of a banking, insurance or similar business.
- Extension of exemption from tax of certain interest related dividends and short term capital gain of regulated investment companies (RICs)
- Extends look through rule related to payments between related controlled foreign corporations for dividends, interest, rent and royalties..
In addition to the various provisions discussed above, some new taxes also took effect January 1 as a result of Health Care Reform Legislation:
- Additional hospital insurance tax on high-income taxpayers: The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. (The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return.) The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.
For self-employed taxpayers, the same additional hospital insurance tax applies on self-employment income in excess of the threshold amount.
- Medicare tax on investment income: A tax is imposed on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (AGI) exceeds a threshold amount (see chart). For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins.
Net investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than income derived in the ordinary course of a trade or business, less expenses applicable to the activity. Income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is also included in investment income.
- Medical care itemized deduction threshold: The threshold for the itemized deduction for unreimbursed medical expenses is increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, when a taxpayer or the taxpayer’s spouse, has turned 65 before the end of the tax year. In this case the threshold remains at 7.5% of AGI.
- Health flexible spending arrangement: 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 any plan year is $2,500.
- No cuts to the Affordable Care Act: This Act avoids (for now) a 27% cut to reimbursements for doctors seeing Medicare patients.
What Was Not Extended
Passage of the Act brought welcome relief to many taxpayers allowing families and businesses to plan for the future. While the Act does extend many provisions, there are many laws which will not be extended. The Act does not include an extension of the 2% cut in payroll and self employment taxes and does not repeal any new Medicare Taxes (see above.) Other provisions not extended include:
- Enhanced charity deduction for gifts of books to public schools and Enhanced charity deduction for gifts of computers for education (however, the Act did extend the Enhanced Charity deduction for contributions of food inventory);
- Expensing of Brownfields environmental remediation costs;
- Refined coal facility fuel credits;
- Section 1603 grants in lieu of energy credits;
- DC and Go Zone investment incentives;
The President kept his promise by asking the wealthiest individuals to pay more while protecting 98% of middle class families and smaller businesses from any tax increases. Overall, this Act is expected to raise $620 billion in revenue. The Act does not address many corporate provisions, perceived loopholes and carried interest for partnerships having service partners. It does not tackle reduction in services or spending cuts. These issues are expected to be revisited early in the year as the debt ceiling discussions progress.
The text of the entire Act can be found here:
Should you have any further questions related to the Act or how the laws may affect your or your business, please contact your Marcum Tax Advisor.