Tax Law Changes for 2013
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 so-called "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. In one immediately noticeable effect, the American Taxpayer Relief Act does not extend the 2012 employee-side payroll tax holiday.
The American Taxpayer Relief Act (the Act) is intended to bring some certainty to the Tax Code. At the same time, it sets stage for comprehensive tax reform, possibly in 2013. Moreover, it creates important planning opportunities for taxpayers, which we can discuss in detail.
A few highlights of the Act include the following:
Individual Tax Provisions
Payroll tax cut
Capital gain and dividend rates
PEP limitations to apply to "high-earners"
Pease limitations to apply to "high-earners"
Permanent AMT relief
Transfer tax provisions
Recovery Act extenders
Historical individual extenders
Business Tax Provisions
Bonus depreciation/small business expensing
Small business stock.
View the Full Text of the Act Here
Individual Tax Provisions
Tax rates. For tax years beginning after 2012, the income tax rates for most individuals will stay at 10%, 15%, 25%, 28%, 33% and 35%. However, a 39.6% rate applies for income above a certain threshold. The applicable threshold is $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. These dollar amounts will be inflation-adjusted for tax years after 2013.
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 the Social Security wage base (with a similar tax break for self-employed individuals). For 2013, the two percent reduction is no longer available and the 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 save 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.
Capital gain and dividend rates rise for higher-income taxpayers. For tax years beginning after 2012, the top rate for capital gains and dividends will permanently rise to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When accounting for Code Sec. 1411's 3.8% surtax on investment-type income and gains for tax years beginning after 2012, the overall rate for higher-income taxpayers will be 23.8%. For taxpayers whose ordinary income is generally taxed at a rate below 25%, capital gains and dividends will permanently be subject to a 0% rate. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends. The rate will be 18.8% for those subject to the 3.8% surtax (i.e, those with modified adjusted gross income (MAGI) over $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
PEP limitations to apply to "high-earners." For tax years beginning after 2012, the Personal Exemption Phaseout (PEP), which had previously been suspended, is reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. These dollar amounts will be inflation-adjusted for tax years after 2013.
Pease limitations to apply to "high-earners." For tax years beginning after 2012, the "Pease" limitation on itemized deductions, which had previously been suspended, is reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Thus, for taxpayers subject to the "Pease" limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer's adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013.
Permanent AMT relief. The 2012 Taxpayer Relief Act provides permanent alternative minimum tax (AMT) relief.. Retroactively effective for tax years beginning after 2011, the 2012 Taxpayer Relief Act permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, the Act indexes these exemption amounts for inflation.
Transfer tax provisions kept intact with slight rate increase. The Act prevents steep increases in estate, gift and generation-skipping transfer (GST) taxes that were slated to occur for individuals dying and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation). However, the Act also permanently increases the top estate, gift and rate from 35% to 40%. The Act also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion amount to the surviving spouse. All changes are effective for individuals dying and gifts made after 2012.
Recovery Act extenders. The Act extends for five years the following items that were originally enacted as part of the American Recovery and Investment Tax Act of 2009 and that were slated to expire at the end of 2012:
- the American Opportunity tax credit, which permits eligible taxpayers to claim a credit equal to 100% of the first $2,000 of qualified tuition and related expenses, and 25% of the next $2,000 of qualified tuition and related expenses (for a maximum tax credit of $2,500 for the first four years of post-secondary education);
- eased rules for qualifying for the refundable child credit; and
- various earned income tax credit (EITC) changes relating to higher EITC amounts for eligible taxpayers with three or more children, and increases in threshold phaseout amounts for singles, surviving spouses, and heads of households.
Historical individual extenders. The Act also extended many items beyond their prior termination date, of which several are highlighted below:
- the exclusion for discharge of qualified principal residence indebtedness, which applied for discharges before Jan. 1, 2013 and which now continues to apply for discharges before Jan. 1, 2014;
- mortgage insurance premiums treated as qualified residence interest,
- the option to deduct State and local general sales taxes,
- the special rule for contributions of capital gain real property made for conservation purposes,
the above-the-line deduction for qualified tuition and related expenses,
tax-free distributions from individual retirement plans for charitable purposes. Because 2012 has already passed, a special rule permits distributions taken in 2012 to be transferred to charities for a limited period in 2013. Another special rule permits certain distributions made in 2013 as being deemed made on Dec. 31, 2012.
Pension provision. For transfers after Dec. 31, 2012, in tax years ending after that date, plan provisions in an applicable retirement plan (which includes a qualified Roth contribution program) can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution under Code Sec. 408A(e).
Business Tax Provisions
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 investment limit.
Small business stock. To encourage investment in small businesses, the tax laws in recent years have allowed noncorporate 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 Act extends the 100 percent exclusion from the sale or exchange of small business stock through 2013.
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
Energy. For individuals and businesses, the new law extends some energy tax incentives. Code Sec. 25C, 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.
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CIRCULAR 230 DISCLOSURE: To ensure compliance with recently-enacted U.S. Treasury Department Regulations, we are now required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including any attachments, is not intended or written by us to be used, and cannot be used, by anyone for the purpose of avoiding federal tax penalties that may be imposed by the federal government or for promoting, marketing or recommending to another party any tax-related matters addressed herein.