The American Taxpayer Relief Act of 2012 (A focus on the Income Tax Aspects)
By: Benjamen P. Reese - Tax Semi-Senior
The White House and Congress celebrated the New Year by abandoning hopes for a “grand bargain” and instead passed legislation that focuses on tax provisions while postponing the “sequester” spending cuts until March. Known as The American Taxpayer Relief Act of 2012, the bill extends many provisions of the 2001 and 2003 tax cuts while hoping there will be opportunities for broader tax reform.
With the sequester cuts looming in March and the debt limit approaching, it is highly probable that tax policy will continue to be prominent in the national narrative in 2013. The future still remains uncertain, but the current legislation answers many questions that were previously unknown.
For 2013, a new top marginal tax bracket has been created for high earners. Taxable income over $450,000 for married taxpayers filing joint returns ($400,000 for single filers) will be taxed at 39.6 percent. Also for taxpayers in this bracket, the long-term capital gains rate will increase to 20 percent, but only on the amount that exceeds $450,000. If the taxpayers taxable income exceeds $450,000 before considering their long-term capital gain, then the entire amount of their long-term capital gain will be subject to the 20 percent.
For taxpayers with taxable income below this amount, the 2001 and 2003 tax cuts were largely extended. The marginal rates below the 39.6 percent bracket were extended permanently, also leaving intact the capital gains rates of 15 percent or zero percent. Qualified dividends will still be taxed as long term capital gain rates.
High income individuals may also be subject to the 3.8 percent Medicare surtax on net investment income that goes into effect for 2013 as a result of the Patient Protection and Accordable Care Act. This provision imposes the tax on net investment income, but not to exceed the amount by which a taxpayer’s adjusted gross income exceeds a threshold ($250,000 for joint filers, $200,000 for single filers).
Congress declined to extend the two percent reduction in Social Security tax paid by employees. For 2013, employees will pay 6.2 percent in Social Security tax on wages up to $113,700. With tax legislation passed as part of the health care overhaul, an additional 0.9 percent in Medicare taxes will be levied on earned income over $250,000 for joint filers and $200,000 for single filers. Both the Social Security and Medicare tax changes may also affect those paying self-employment taxes.
Notable Business Provisions
The 50 percent bonus depreciation benefit has been extended through 2013. In addition, the section 179 deduction has been extended through 2012 and 2013. Taxpayers will still be able to deduct up to $500,000 if the total capital investment does not exceed $2,000,000. This provision would have been significantly lower if we went over the so-called fiscal cliff.
Also, the class life for qualified leasehold and restaurant property will remain at 15 years. This would have increased to 39 years for leasehold property if Congress failed to act, and restaurants would have lost qualified property privileges altogether.
The research and development credit was also extended for 2012 and 2013, however, it was not made permanent. This credit rewards businesses that increase research and development activities from year to year.
The work opportunity credit was extended, allowing employers who hire from targeted groups to recoup a portion of that employee’s salary up to $6,000, or $9,600 for some qualified veterans.
Further, the 100 percent exclusion on gain for qualified small business stock was extended. Gains from qualified stock held for more than five years can be excluded from income up to $5 million.
Alternative Minimum Tax
The IRS previously warned of possible delays in the filing season for millions if the AMT “patch” was not enacted. Not only was the government concerned, but millions of taxpayers were being faced with being subject to the tax for the first time. Congress took note and managed to pass a permanent patch of the AMT, thereby reducing the impending tax for those taxpayers who are subject to the AMT.
Prior to the new legislation, the AMT exclusion would need to be manually adjusted as part of larger tax legislation each time it expired, something that will no longer be necessary. With the uncertainty removed from the equation, the AMT exclusion will be $78,750 for married taxpayers filing joint returns and $50,600 for single filers. These amounts will now automatically be updated according to standard cost-of-living adjustments that are already a component of the Internal Revenue Code. Additionally, taxpayers will also continue to have the benefit of applying nonrefundable credits against the AMT.
Itemized Deductions, Pease Limitations, and Exemptions
Pease limitations will once again be in effect beginning in 2013. The Pease limitation limits itemized deductions for taxpayers with adjusted gross income over a threshold amount that is adjusted for inflation. However, Congress was more generous than inflation when determining a threshold. Without Congressional action, the threshold would have been reinstated at $178,150 for joint filers. These limitations will go into effect at $300,000 of AGI for joint filers and $250,000 for single filers. Three percent of the excess AGI will be subtracted from the itemized deductions, with a maximum limitation of 80 percent.
Similar to the Pease limitation, personal exemption amounts will be phased out for taxpayers with AGI over the same thresholds noted above. The personal exemption will be phased out by two percent for each increment of $2,500 over the AGI threshold. While the IRS has not yet issued guidance regarding the 2013 exemption amount, it is estimated to be $3,900. Thus, a taxpayer and spouse filing jointly with AGI of $350,000 and no dependents would have personal exemptions reduced to $4,680 from $7,800.
Congress also extended the provisions allowing premiums for mortgage insurance to be deducted as qualified residence interest.
Taxpayers will continue to have the option to deduct state and local sales taxes in lieu of state and local income taxes. This is beneficial for taxpayers who live in states that do not have a personal income tax or who have made large purchases during the tax year.
Taxpayers with a 401k retirement plan will now be able to convert their portfolio to a Roth 401k. This was allowed previously, but the funds had to be considered distributable. Under the new legislation, that requirement no longer applies and taxpayers across the board can convert their holdings to Roth by paying the tax due on the amount transferred, provided their plan offers designated Roth accounts and allows the rollover.
The tuition and fees deduction was extended through 2013 and is similar to previous years, allowing for a deduction of up to $4,000 for taxpayers not exceeding income limitations. In addition, the American opportunity tax credit has been extended for another five years, offering additional options for students and their families.
The student loan interest deduction was extended to permanently include provisions from the 2001 tax cuts. These provisions allowed for the deduction of interest even after 60 months of repayment provided that AGI did not exceed phase-out limits. Higher limits that were created in previous tax cuts were also made permanent.
The $250 deduction for qualified expenses by elementary and secondary school teachers was extended through 2013 after expiring at the end of 2011. In addition, costs substantiated in excess of this amount will still be eligible as an itemized deduction subject to a two percent AGI floor.
Permanent extensions were also granted to the child tax credit, which remains at $1,000, and the earned income credit. The child and dependent care credit was also extended.
Not only were income taxes affected by this legislation, but there were also changes to the estate and gift tax. A separate article discussing the estate and gift tax aspects of the American Taxpayer Relief Act of 2012 can be found at the following location: http://www.alpern.com/taxpayer-relief-act-estate-gift.php.
Essentially, the American Taxpayer Relief Act of 2012 certainly is not the fiscal panacea sought by Congress. Largely, it prevents the 2001 and 2003 cuts from expiring altogether and threatening economic recovery. However, the changes outlined above will certainly have an impact on taxpayers. As Congress continues to strive for tax reform going forward, we will be sure to keep you updated on the ever-evolving legislative landscape.
If you have any questions or concerns about your unique situation, or would like more information about the American Taxpayer Relief Act of 2012, please contact your Alpern Rosenthal representative.