After weeks, indeed months of proposals and counter-proposals, seemingly endless negotiations
and down-to-the-wire drama, Congress has passed legislation to avert the tax side of the socalled
“fiscal cliff.” The American Taxpayer Relief Act permanently extends the Bush-era tax
cuts for lower and moderate income taxpayers, permanently “patches” the alternative minimum
tax (AMT), provides for a permanent 40 percent federal estate tax rate, renews many individual,
business and energy tax extenders, and more.
The American Taxpayer Relief Act is intended to bring some certainty to the Tax Code. At the
same time, it sets the stage for comprehensive tax reform, possibly in 2013. Moreover, it creates
important planning opportunities for taxpayers, which we can discuss in detail.
If Congress had done nothing, tax rates would have increased for all taxpayers at all income
levels after 2012. Both the White House and GOP realized that going over the fiscal cliff would
jeopardize the economic recovery, and the American Taxpayer Relief Act is, for the moment,
their best compromise.
Tax Rates – The American Taxpayer Relief Act extends permanently the Bush-era income tax
rates for all taxpayers except for taxpayers with taxable income above certain thresholds:
$400,000 for single individuals, $450,000 for married couples filing joint returns, and $425,000
for heads of households. For 2013 and beyond, the federal income tax rates are 10, 15, 25, 28,
33, 35, and 39.6 percent. In comparison, the top rate before 2013 was 35 percent. The IRS is
expected to issue revised income tax withholding tables to reflect the 2013 rates as quickly as
possible and provide guidance to employers and self-employed individuals.
Additionally, the new law revives the limitation on itemized deductions and personal exemption
phase out (PEP) after 2012 for higher-income individuals, but at revised thresholds. The new
thresholds for being subject to both of these limitations after 2012 are $300,000 for married
couples and surviving spouses, $275,000 for heads of households, $250,000 for unmarried
taxpayers; and $150,000 for married couples filing separate returns.
Capital Gains – The capital gains and dividend tax rates are modified by the American Taxpayer
Relief Act. Generally, the new law increases the top rate for qualified capital gains and dividends
from 15 to 20 percent to the extent that a taxpayer’s income exceeds the
$400,000/$425,000/$450,000 thresholds discussed above. The 15 percent tax rate will continue
to apply to all other taxpayers (in some cases, zero percent for qualified taxpayers within the 15
percent or lower income tax bracket).
Payroll Tax Cut – The employee-side payroll tax holiday is not extended. Before 2013, the
employee share of OASDI taxes was reduced by two percentage points from 6.2 percent to 4.2
percent up to the Social Security wage base (with a similar tax break for self-employed
individuals). For 2013, the 2 percent reduction is no longer available and employee-share of
OASDI taxes reverts to 6.2 percent. The employer-share of OASDI taxes remains at 6.2 percent.
In 2012, the payroll tax holiday could have saved a taxpayer up to $2,202 (taxpayers earning at
or above the Social Security wage base for 2012). As a result of the expiration of the payroll tax
holiday, everyone who receives a paycheck or self-employment income will see an increase in
taxes in 2013.
AMT – In recent years, Congress routinely “patched” the AMT to prevent its encroachment on
middle income taxpayers. The American Taxpayer Relief Act patches permanently the AMT by
giving taxpayers higher exemption amounts and other targeted relief. This relief is available
beginning in 2012 and going forward. The permanent patch is expected to provide some
certainty to planning for the AMT. No single factor automatically triggers AMT liability, but
some common factors are itemized deductions for state and local income taxes; itemized
deductions for miscellaneous expenditures, itemized deductions on home equity loan interest
(not including interest on a loan to build, buy, or improve a residence); and changes in income
from installment sales. Our office can help you gauge if you may be liable for the AMT in 2013
or future years.
Child Tax Credit and Related Incentives – The popular $1,000 child tax credit was scheduled to
revert to $500 per qualifying child after 2012. Additional enhancements to the child tax credit
also were scheduled to expire after 2012. The American Taxpayer Relief Act makes permanent
the $1,000 child tax credit. Most of the Bush-era enhancements are also made permanent or
extended. 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 American Taxpayer Relief Act. The American Opportunity Tax Credit (an
enhanced version of the Hope education credit) is extended through 2017. Enhancements to
Coverdell education savings account, such as the $2,000 maximum contribution, are made
permanent. The student loan interest deduction is made more attractive by the permanent
suspension of its 60-month rule (which had been scheduled to return after 2012). The new law
also extends permanently the exclusion from income and employment taxes of employerprovided
education assistance up to $5,250 and the exclusion from income for certain military
scholarship programs. Additionally, the above-the-line higher education tuition deduction is
extended through 2013, as is the teachers’ classroom expense deduction.
Charitable Giving – Congress has long used the tax laws to encourage charitable giving. The
American Taxpayer Relief Act extends a popular charitable giving incentive through 2013: taxfree
IRA distributions to charity by individuals age 70½ and older up to maximum of $100,000
for qualified taxpayer per year. A special transition rule allows individuals to re-characterize
distributions made in January 2013 as made on December 31, 2012. The new law also extends
for businesses the enhanced deduction for charitable contributions of food inventory.
Federal Estate Tax – Few issues have complicated family wealth planning in recent years, as has
the federal estate tax. Recent laws have changed the maximum estate tax rate multiple times.
Most recently, the 2010 Tax Relief Act set the maximum estate tax rate at 35 percent with an
inflation-adjusted exclusion of $5 million for estates of decedents dying before 2013. Effective
January 1, 2013, the maximum federal estate tax will rise to 40 percent, but will continue to
apply an inflation-adjusted exclusion of $5 million. The new law also makes permanent
portability between spouses and some Bush-era technical enhancements to the estate and
generation-skipping transfer taxes.
The business tax incentives in the new law, while not receiving as much press as the individual
tax provisions, are valuable. Two very popular incentives, bonus depreciation and small business
expensing, are extended, as are many business tax “extenders.”
Bonus Depreciation/Small Business Expensing – The new law renews 50 percent bonus
depreciation through 2013 (2014 in the case of certain longer period production property and
transportation property). Code Sec. 179 small business expensing is also extended through 2013
with a generous $500,000 expensing allowance and a $2 million investment limit. Without the
new law, the expensing allowance was scheduled to plummet to $25,000 with a $200,000
Small Business Stock – To encourage investment in small businesses, the tax laws in recent years
have allowed non-corporate taxpayers to exclude a percentage of the gain realized from the sale
or exchange of small business stock held for more than five years. The American Taxpayer
Relief Act extends the 100 percent exclusion from the sale or exchange of small business stock
Tax Extenders – A host of business tax incentives are extended through 2013. These include:
Research tax credit
Work Opportunity Tax Credit
New Markets Tax Credit
Employer wage credit for military reservists
Tax incentives for empowerment zones
Indian employment credit
Railroad track maintenance credit
Subpart F exceptions for active financing income
Look-through rules for related controlled foreign corporation payments
For individuals and businesses, the new law extends some energy tax incentives. The Code Sec.
25C credit, which rewards homeowners who make energy efficient improvements, with a tax
credit is extended through 2013. Businesses benefit from the extension of the Code Sec. 45
production tax credit for wind energy, credits for biofuels, credits for energy-efficient appliances,
and many more.
The negotiations and passage of the new law are likely a dress rehearsal for comprehensive tax
reform. Both the President and the GOP have called for making the Tax Code more simple and
fair for individuals and businesses. The many proposals for tax reform include consolidation of
the current individual income tax brackets, repeal of the AMT, moving the United States from a
worldwide to a territorial system of taxation, and a reduction in the corporate tax rate. Congress
and the Obama Administration also must tackle sequestration, which the American Taxpayer
Relief Act delayed for two months. All this and more is expected to keep federal tax policy in the
news in 2013. Our office will keep you posted of developments.
If you have any questions about the American Taxpayer Relief Act, please contact our office.
We can schedule an appointment to discuss how the changes in the new law may be able to
maximize your tax savings
WM. F. HORNE & CO., PLLC