On January 1, the U.S. Senate finally took up H.R. 8 which had passed the U.S. House in late July. The Senate renamed the bill as “The American Taxpayer Relief Act of 2012” and made changes to it and shipped it back to the House. The House approved the changes late on January 1. The President signed the legislation into law on January 2, 2013.
The Act represents “permanency” of key parts of the EGTRRA provisions of 2001, but also significant tax increases. We will detail all of the significant provisions of the Act during the January 14 webinar. One provision that was not dealt with was the payroll tax cut. That was allowed to expire. Thus, all wage earners will see a tax increase next year. For our purposes here, the following is a brief summary of the Act’s primary provisions.
Note: The Iowa Department of Revenue will be recommending legislation to couple with all changes except the 50 percent bonus depreciation provision for 2013.
- Permanency of the EGTRRA individual tax rates (10, 15, 25, 28, 33 and 35 percent). However, the Act does impose a 39.6 percent rate on incomes above $450,000 (MFJ), $400,000 (single), and $225,000 (MFS). The thresholds are indexed for inflation starting in 2014 (for tax years after 2013). With respect to that top bracket, a significant marriage penalty is imposed.
- Big marriage penalty and tax increase for those with incomes less than $450,000, etc. As noted above, married persons filing jointly or separately hit the threshold at $450,000, but two unmarried persons living together would each have their own $400,000 threshold. Likewise, the phaseout of personal exemptions starts at $300,000 for those filing statuses MFJ and surviving spouse. It starts at $275,000 (HH), $250,000 (single) and $150,000 (MFS). Once the applicable threshold is exceeded, otherwise available exemptions drop by 2 percent for every $2,500 (or portion thereof) that the taxpayer’s AGI is over the threshold. This provision is also inflation-indexed for tax years that begin after 2013. Also, the same thresholds apply to the phaseout of itemized deductions. Once the applicable threshold is exceeded, itemized deductions are given a 3 percent “haircut” with the reduction capped at 80 percent of the otherwise allowable itemized deductions. Because the thresholds are lower for these provisions than with respect to the beginning of the 39.6 percent rate, taxpayers with incomes less than the threshold for the beginning of the 39.6 rate will see an effective tax increase.
- Capital gains and dividends. Under the Act, the top capital gain and dividend rate rises to 20 percent for taxpayers with incomes exceeding the $450,000 threshold (MFJ) $400,000 for other taxpayers (again, note the marriage penalty). The zero percent rate is retained for taxpayers with ordinary income taxed at an individual income tax rate less than 25 percent. For taxpayers that are in between, a 15 percent rate applies. In addition, starting in 2013, a Medicare surtax of 3.8 percent is imposed on passive gains. So, if a capital gain is passive (as defined under the health care law and regulations), the effective capital gain rate is 23.8 percent. Dividends are also passive, so the Medicare surtax also applies to those for persons subject to a 20 percent rate on dividends, effectively making the rate 23.8 percent.
- Permanency of transfer taxes. The Act, effective for transfers after 2012, establishes a $5 million (inflation-adjusted) unified credit exemption equivalent for estate, gift and GSTT purposes. We noted in our monthly newsletter a couple of months ago that the $5 million unified credit amount was a done deal, so that removed the concern for the need to make large gifts by the end of 2012 for those that were paying attention. For 2013, the inflation-adjusted amount is expected to be $5.25 million. Portability of the amount of the unused amount of the exclusion at the death of the first spouse to die is also retained. However, the rate on transfers above the amount covered by the credit is increased to 40 percent. Specifically, under the Act, transfers exceeding $500,000 are taxed at 37 percent, transfers over $750,000 are taxed at 39 percent, and transfers over $1,000,000 are taxed at 40 percent. Thus, if the exemption equivalent of the credit is $5.25 million for 2013, the unified credit for 2013 will be $2,045,800.
The other changes made by the EGTRRA were made permanent. These include the repeal of the state death tax credit (it was replaced with a deduction), the repeal of the QFOB deduction, modification to qualified conservation easement donation rules, technical changes to the installment payment of federal estate tax rules and certain GSTT technical amendments.
- Permanent AMT relief. While the AMT was not eliminated, what the Act imposes is a permanent increase in exemption amounts that are then indexed for inflation retroactive to tax years beginning after 2011.
- Certain provisions extended (most significant ones only):
- The provision allowing tax-free distributions by individuals 70.5 and older (up to $100,000 annually) to charity is retroactively restored for 2012 and extended through 2013. Also, a qualified taxpayer may elect to have a distribution that is made in January of 2013 as being treated as having been made as of December 31, 2012. Likewise, an election can be made to treat any portion of an IRA distribution to the taxpayer made in December of 2012 as a qualified charitable distribution if it is transferred in cash after the distribution to an eligible charity before February 1, 2013 and the distribution otherwise satisfies I.R.C. §408(d)(8).
- First-year “bonus” depreciation is extended through 2013 (through 2014 for certain long-lived assets).
- Expense method depreciation is retroactively reinstated for 2012 at the $500,000 amount (and $2,000,000 investment ceiling) and is extended at that level for 2013. Expense method depreciation will drop to $25,000 beginning in 2014 without additional legislation. Also extended for tax years beginning before 2014 in conjunction with IRS pronouncements on the matter is the ability to make or revoke an expense method depreciation election on an amended return for an open tax year. That is a huge planning opportunity for farm clients, especially if they are planning on selling as asset in 2013 on which they claimed expense method depreciation at an elevated level in a prior year for which the return remains within the statutory timeframe to amend.
- The ability to treat certain types of qualified real property as 15-year MACRS property is retroactively reinstated for 2012 and extended through 2013. Since qualified leasehold improvement property was reinstated for 2012, it is eligible for 50 percent bonus depreciation if placed in service in 2013 or 2014 under the special rule that applies to it under the bonus provision.
- Restored for 2012 and extended through 2013 is the ability to exclude all of the gain on the sale of I.R.C. §1202 stock.
- The Work Opportunity Tax Credit has been restored for non-veterans for 2012 and extended through 2013 for both veterans and non-veterans.
- For tax years beginning in 2012 or 2013, the recognition period for built-in gains of an S corporation is a 5-year period beginning with the first day of the first tax year for which the corporation was an S corporation. Also, effective for tax years beginning after 2011, S corporations that report gain from asset sales under the installment method, all payments that are received will be subject to I.R.C. §1374(d)(7)(E).
- For 2012 and 2013, the above-the-line deduction for elementary and secondary school teachers is available.
- For 2013, the provision allowing discharge of qualified principal residence debt to be excluded from income is available, as is the provision allowing mortgage insurance premiums to be deducted as qualified residence interest. The latter provision was also retroactively reinstated for 2012.
- The qualified tuition deduction is made retroactively available for 2012 and extended through 2013.
- The child tax credit is extended at the $1,000 amount for taxpayers with qualified children through 2017 (tax years beginning before 2018).
- Numerous energy-related provisions were extended, including $12 billion in subsidies for the wind energy industry via the wind energy production tax credit.
- As a revenue-raiser, for transfers after 2012, in tax years ending after 2012, plan provisions in a retirement plan (401(k) can allow plan participants to elect to transfer amounts to a designated Roth account. The transfer will be taxed at ordinary income rates in the year of the transfer.
Why the Act averts the so-called “fiscal cliff,” a Gallup poll taken after passage of the bill shows that most Americans do not approve of the Act. The Act increases taxes on many small business owners and, as noted above, does not extend the payroll tax cut. That will be a particularly hard hit to middle and low-income families, and will hamper the struggling economy, where unemployment was announced (in the January jobs report) as being up in December over November’s rate. Unemployment still remains about 30 percent higher than what the Administration predicted it would be at this time if the 2009 “stimulus” package were not enacted, and 42 percent higher than what the Administration said unemployment would be by the end of 2012 if the stimulus bill were enacted. The major reason that unemployment dipped slightly during 2012 was due to the labor force shrinking. Interestingly, the President made no mention that the average family will have about $1,000 in less income during 2013 when he made his national address after the Congress reached agreement on the legislation.
The Act also include “goodies” for Hollywood, NASCAR and $12 billion for wind energy, $9 billion to help some firms create jobs overseas, an excise tax on rum that goes to Puerto Rico and the Virgin Islands, tax-exempt financing for (among other things) the financing of luxury apartments and new headquarters for Goldman Sachs, a tax break for electric bikes and scooters, and millions in a tax break for American Samoa businesses. The Act also includes (as estimated) only $1 in spending cuts for every $43 in higher taxes. So, the debt problem was not dealt with and the country will face another showdown over the government’s borrowing limit and the debt ceiling in the near future.
As noted above, we will cover all of this and more (including planning scenarios) during the January 14 webinar. Stay tuned.