As you are aware from public media, late last night the House of Representatives approved the Senate’s American Taxpayer Relief Act of 2012, thereby firmly endorsing the adage that “the time it takes to do a job expands to fill the time available to do it.” I’ve read all 157 pages of the Bill and below are the highlights of the tax provisions, as I interpret the legislation, that I think will be important to most taxpayers (individuals and businesses), including some you won’t find in the local papers.
First. A comment on the hype that “taxes for 99% of Americans will not go up as a result of this Bill”; I disagree. This Act deals primarily with income and transfer taxes, but it fails to extend the 2% payroll tax reduction that has been in place for the past two years. The IRS has instructed employers to begin withholding the increased payroll tax from employee checks as soon as possible. That means your social security tax withholding from each paycheck will increase from 4.2% to 6.2% (note: that’s almost a 50% increase) on the first $113,700 of wages for 2013, or a potential annual increase of almost $2,300 for the highest wage earners. This will also affect those individuals who are subject to self-employment tax.
Income Tax Rates. Effective for 2013, the highest marginal tax rate now climbs to 39.6% (up from 35% – a 13% increase) on taxable incomes in excess of $450,000 for married persons filing jointly, $400,000 for single taxpayers, $425,000 those filing as head of household, $225,000 for married persons filing separately, and $7,500 for non-grantor trusts and estates. These amounts will be adjusted for inflation beginning in 2013.
Phase-out of Itemized Deductions. The benefit of itemized deductions is again limited for high-income individuals. These benefits begin to phase out for taxpayers with adjusted gross income of $300,000 for married taxpayers filing jointly, $250,000 for single taxpayers, $275,000 for those filing as head of household, $150,000 for married taxpayers filing separately. This provision does not apply to non-grantor trusts and estates. These amounts will also now be adjusted for inflation.
Phase-out of Personal Exemptions. The benefit of many personal exemptions is also again limited for high-income taxpayers. The phase-out begins at the same amount of adjusted gross income as for the phase-out of itemized deductions discussed above. Medical expenses, investment interest and casualty, theft, and wagering losses are not subject to the phase-out.
Estate, Gift, and Generation-Skipping Transfer Taxes. The exclusion amount for transfers at death, during lifetime, and for generation-skipping transfers remains at $5 million (as currently indexed for inflation to $5.12 million for 2012), but the maximum rate on transfers in excess of this amount increases from 35% to 40%. “Portability” is now made permanent. These provisions are effective for decedents dying, generation-skipping transfers, and lifetime gifts after December 31, 2012.
Capital Gains and Dividends. The maximum tax rate on long-term capital gains and qualified dividends increases by one-third from 15% to 20% for higher income individuals using the same $450,000, $400,000, etc. thresholds for ordinary income. Remember, however, that both interest and dividends for all taxpayers are subject to an additional 3.8% Medicare tax after 2012.
Alternative Minimum Tax. ALTMIN has been a perennial problem because the low exemption amount that threatens to subject to millions of taxpayers to the ALTMIN flat tax rates each year. To mitigate this problem, Congress has been required to “patch” the exemption amount every year with an inflation adjustment. The permanent exemption amount has now been raised to current the level and the annual inflation adjustment has finally been made permanent. In addition, all non-refundable tax credits that apply to one’s regular income tax will apply to the ALTMIN tax for years after 2011.
Conversion of Section 401(k) Plans to Roth IRAs. This is a fund raising provision to incentivize individuals with large balances in 401(k) plans to convert those balances to Roth IRAs by paying the income tax on the converted amounts now in exchange for continued tax-free growth, tax-free distributions in the future, and elimination of the annual minimum distribution requirement at age 69-1/2. We have had this opportunity for regular IRAs for years but it did not include 401(k) plans. The decision to convert is highly complicated and depends on your time horizon for distributions, and your guess as to future tax rates and rates of growth and inflation. Get professional investment advice before jumping off and converting.
Extenders. Certain expired or expiring provisions have been extended. These include (but are certainly not limited to):
- the American Opportunity Tax Credit (for education) through 2017;
- the basic $1,000 Child Tax Credit is made permanent and the $3,000 earnings threshold for the refundable portion of this credit is extended through 2017;
- the Earned Income Tax Credit through 2017;
- above-the-line deduction for $250 of certain educator expenses for 2012 and 2013;
- the $2 million income exclusion from discharge of mortgage income debt on a principal residence is extended through 2013;
- mortgage insurance premiums treated as qualified residential interest for 2012 and 2013;
- the election to deduct certain state and local sales taxes (in lieu of state and local income taxes) for 2012 and 2013;
- charitable contribution deduction of capital gain real property for conservation purposes for 2012 and 2013;
- above-the-line deduction for certain qualified tuition and related expenses for 2012 and 2013;
- tax-free distributions from IRAs (but still not 401(k) plans) for charitable purposes by individuals 70-1/2 or older years of age is extended for 2012 and 2013. Importantly, the Bill provides a couple of planning opportunities for these distributions. The first is that such distributions made in January of 2013 may be recharacterized as having been made in December of 2012. The second is that an otherwise taxable distribution from an IRA to an individual taken in December of 2012 may be excluded from 2012 income if transferred to charity during January of 2013;
- the business research tax credit for 2012 and 2013;
- employer wage credit for employees who are active duty military for 2012 and 2013;
- work opportunity tax credit for 2012 and 2013;
- 15-year straight-line depreciation period for specified leasehold improvements for 2012 and 2013;
- enhanced charitable contribution deduction for gifts of food inventory for 2012 and 2013;
- the election to expense, rather than depreciate, $500,000 of certain business property, including certain computer software, will apply in 2013, but still reverts to $25,000 in 2014;
- exclusion of 100 percent of the gain realized on certain small business (not S corporation) stock is extended for 2012 and 2013;
- basis adjustment to the stock of S corporations for charitable contributions of property for 2012 and 2013;
- 5-year (rather than 10-year) period for reduction for S corporation built-in gains tax is extended for 2012 and 2013;
- bonus first-year depreciation for 2012 and 2013; and
- credit for energy-efficient new and existing homes and appliances for 2012 and 2013.
I realize that this is a long summary and it only addresses the tax provisions, not pages and pages of health care changes and the extension of unemployment benefits. You will be pleased to note, however, that as a result of this Bill, milk is not going to $7 a gallon this week. Also remember that this legislation only gets us over the first “fiscal cliff.” We now face three more in the next few months.
If you have questions, please call or email me.
Copyright 2013 Ronnie C. McClure, PhD, CPA