December 2012 – Significant Developments

December 3, 2012 | Roger McEowen

Tax legislation signed into law on January 2 (The American Taxpayer Relief Act of 2012) makes permanent some very significant provisions of EGTRRA enacted in 2001.  The Act also extends some provisions that had either already expired at the end of 2011 or expired at the end of 2012.

  • There is a permanent extension of the 10 percent individual income tax bracket, along with the permanent extension of the 25%, 28%, 33% and 35% rates for incomes at or below $400,000 (single filers) and $450,000 (joint filers) and $425,000 (heads of households).  But, those above those thresholds will be subject to tax at a 39.6% rate. 
  • There is also a permanent repeal of the personal exemption phaseout for certain taxpayers, although the thresholds for this one is lower than the thresholds for the individual income tax brackets.  In addition, the Act permanently repeals the itemized deduction limitation for taxpayers with income beneath a certain threshold. 
  • As for capital gains and dividends, the EGTRRA provisions were also made permanent except that the top rate will be 20 percent fro taxpayers with income in excess of $400,000 ($450,000 MFJ).  Thus, the rate for these taxpayers will be 23.8% when the new Medicare surtax is added on.  But, for those taxpayers with ordinary income tax rates below 25 percent, capital gains and dividends will be subject to a 0% rate.  For taxpayers with income beneath the $400,000/$450,000 threshold, but who are in a tax bracket of 25 percent or more, will be subject to a 15 percent rate for capital gains and dividends – which could be as high as 18.8 percent if the 3.8 percent Medicare surtax applies.
  • Higher income taxpayers are subject to a phaseout of personal exemptions, and a limitation on itemized deductions.
  • The AMT exemption is permanently increased and indexed (retroactive to tax years beginning after 2011), and certain personal, nonrefundable credits will be allowed as an offset against AMT and regular tax.
  • First-year “bonus depreciation is extended through 2013.
  • 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.  It is schedule to drop to $25,000 beginning in 2014.  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 your farm clients, especially if they are planning on selling an asset in 2013 on which they took expense method depreciation at an elevated level in a prior year for which the return is still within the statutory timeframe to amend.
  • Extended through 2013 is the treatment of certain types of qualified real property as 15-year MACRS property.
  • Also, the provision allowing tax free distributions from an IRA to charity for persons over age 70.5 (up to $100,000 per year) is restored for 2012 and extended through 2013.
  • Also restored is the 100 percent exclusion of gain upon sale of I.R.C. §1202 stock for 2012 and 2013.
  • The Work Opportunity Tax Credit will apply through 2013 for both veterans and non-veterans.  For non-veterans, therefore, the provision is retroactively reinstated for 2012.
  • 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.
  • The Act reinstates for 2012 and extends through 2013, the above-the-line deduction for elementary and secondary school teachers.
  • For 2013, the provision allowing discharge of qualified principal residence debt to be excluded from income is extended, and the provision allowing mortgage insurance premiums to be deducted as qualified residence interest is reinstated for 2012 and extended for 2013.
  • Numerous education and energy related provisions were extended, including $12 billion in subsidies for the wind energy industry via the wind energy production tax credit.
  • For transfers after 2012, in tax years ending after 2012, plan provisions in a retirement plan can allow plan participants to elect to transfer amounts to a designated Roth account.  The transfer will be taxed at ordinary income rates.
  • The federal estate tax unified credit exemption equivalent remains at $5 million for estate and gift tax purposes and is adjusted for inflation.  The expectation is that the amount will be about $5.25 million per decedent for 2013.  Portability of the unused exclusion amount at the death of the first spouse is retained.  The tax rate applicable to transfers beyond the applicable exclusion amount is increased to 40 percent.  The estate and gift tax system remains coupled.

The list above is not comprehensive, but just an attempt to highlight some of the most relevant provisions.  We will address all of these changes and more at the Jan. 14, 2013 webinar, and provide some planning insights with these provisions in mind along with addressing the 3.8% Medicare surtax regulations that were recently issued and what they mean for your clients.