by Robert Hodges >
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The 2012 American Taxpayer Relief Act (the “Act”) is a far-reaching tax package enacted in response to the “fiscal cliff.” The Act includes, among many other items, permanent extension of the Bush-era tax cuts for most individuals; revised income tax rates on ordinary and capital gain income for some individuals; modification of the estate tax rates; permanent relief from the alternative minimum tax (“AMT”) for individual taxpayers; limits on the deductions and exemptions of high-income individuals; and a number of retroactive or extended tax breaks for individuals and businesses. In addition, certain tax provisions of the Affordable Care Act (“ACA”) become effective in 2013.
Tax rates. For the tax year 2013 and beyond, the Act makes tax brackets reflecting the Bush-era tax cuts permanent. The new law, however, also imposes a 39.6% income tax rate on income over $400,000 (single), $425,000 (head of household), $450,000 (joint filers and qualifying widows), and $225,000 (married filing separately). Trusts and estates with $11,950 or more in taxable income are also subject to the 39.6% income tax rate. A table summarizing the tax brackets for single individuals and married couples filing jointly is included for your reference below.
SINGLE MARRIED FILING JOINTLY
Income Rate Income Rate
$0 to $8,950 10% $0 to $17,850 10%
$8,950 to $36,250 15% $17,850 to $72,500 15%
$36,250 to $87,850 25% $72,500 to $146,400 25%
$87,850 to $183,250 28% $146,400 to $223,050 28%
$183,250 to $398,350 33% $223,050 to $398,350 33%
$398,350 to $400,000 35% $398,350 to $450,000 35%
Greater than $400,000 39.5% Greater than $450,000 39.6%
Capital gains and qualified dividends rates. As summarized in the table below, the Act retains preferred income tax rates on long-term capital gains and qualified dividends. The Act, nevertheless, establishes a new 20% capital gains rate for taxpayers with higher incomes. It should also be noted the capital gains and dividend rates do not reflect the 3.8% Medicare surcharge resulting from the passage of the ACA. The surcharge becomes effective in 2013 and imposes additional income taxes on “investment income” for taxpayers with modified adjusted gross income in excess of $200,000 (single) and $250,000 (married filing jointly). Additional specifics regarding the surcharge are discussed below.
SINGLE MARRIED FILING JOINTLY
Income Capital Gain Rate Income Capital Gain Rate
$0 to $8,950 0% $0 to $17,850 0%
$8,950 to $36,250 0% $17,850 to $72,500 0%
$36,250 to $87,850 15% $72,500 to $146,400 15%
$87,850 to $183,250 15% $146,400 to $223,050 15%
$183,250 to $398,350 15% $223,050 to $398,350 15%
$398,350 to $400,000 15% $398,350 to $450,000 15%
Greater than $400,000 20% Greater than $450,000 20%
Personal exemption phaseout. Personal exemptions will be reduced for individual taxpayers with adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). The phase out, sometimes referred to as a “stealth tax,” will push the marginal income tax rate higher by up to 4% for taxpayers with income over the respective thresholds.
Itemized deduction limitation. Beginning in 2013, itemized deductions will be limited for taxpayers with adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). This limitation will also raise the marginal rate of taxpayers who itemize deductions.
AMT relief. The Act provides permanent AMT relief through a boost in the AMT exemption amounts to $50,600 (single), $78,750 (married filing jointly) and $39,375 (married persons filing separately). Unlike the previous AMT exemptions, these exemption amounts are indexed for inflation and will rise over time. The AMT relief is retroactively effective for tax year 2012 and this change may be beneficial as you file your 2012 income tax returns.
Tax credits. The Act extends the American Opportunity tax credit. The credit provides up to $2,500 in refundable tax credits for undergraduate education. Further, the Act eases rules for qualifying for the refundable child credit and makes various earned income tax credit (“EITC”) changes. The New Markets Tax Credit was also extended to the 2012 and 2013 tax years.
Expiration of payroll tax cut. The 2% payroll tax cut expired at the end of 2012. Further, commencing in the 2013 tax year, the ACA adds a .09% wage and self-employment income tax for income in excess of $200,000 (single), $250,000 (married filing jointly), and $125,000 (married filing separately).
Medicare Tax on Investment Income. Another provision of the ACA that becomes effective for tax years beginning in 2013 is the extension of the 3.8% Medicare tax to “investment income” for taxpayers with modified gross income in excess of $200,000 (single) and $250,000 (married filing jointly). The tax will also apply to trusts with modified adjusted gross income in excess of $11,950. Previously, this tax only applied to wages and self-employment income. In the context of the Medicare tax “investment income” includes interest, dividends royalties, net rental income, and net passive income from a trade or business activity in which the taxpayer does not materially participate.
Enhanced small business expensing (Section 179 expensing). Generally, the cost of property in a trade or business must be “capitalized” and depreciated over a period of years. However, small business taxpayers may elect to deduct the cost of qualifying property in the year it is placed in service instead of recovering the cost through depreciation. The expense election is available, on a tax year by tax year basis, under Section 179 of the Internal Revenue Code, subject to a cap on the amount of Section 179 expenses that can be claimed for any given year. For the 2012 (retroactive) and 2013 tax years, the Act provides that a small business taxpayer is allowed to deduct up to $500,000 of capital expenditures subject to a phaseout (i.e., gradual reduction) once capital expenditures exceed $2,000,000. For tax years 2014 and beyond, the maximum expensing amount will drop to $25,000 and the phaseout level will also be reduced. The Act extends the treatment of off-the-shelf computer software as qualifying property through the 2013 tax year. Furthermore, the new law extends through 2013 the provision permitting a taxpayer to amend or irrevocably revoke a Section 179 election without the Internal Revenue Service’s consent.
Extension of additional first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, by permitting an additional first-year write-off. The Act extends this additional first-year depreciation for some capital assets.
Estate tax. The Act prevents steep increases in estate, gift and generation-skipping transfer (“GST”) tax scheduled to occur in 2013. The exemption for 2013 is $5,250,000 and will rise with inflation. In addition, the Act permanently increases estate, gift, and GST tax rates from 35% to 40%. The portability feature that allows a surviving spouse to utilize a deceased spouse’s unused exemption amount has also been made permanent.
Although the Act prevents many of the dramatic tax consequences associated with the “fiscal cliff,” you should expect to pay additional income taxes in 2013 as a result of the law changes described above. As always, consultation with your tax advisor is recommended regarding the impact of the tax law changes.
Robert D. Hodges is an associate at BrownWinick and practices primarily in the areas of taxation, estate planning and business law. Bob can be reached at (515) 242-2465 or email@example.com.
NOTE: This article is not meant to be a comprehensive review of the changes in the tax law for 2013.
IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that, except to the extent expressly provided to the contrary, any federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.