Highlights of the American Taxpayer Relief Act of 2012
Federal Tax Outlook for Individuals for 2013
On January 2, 2013, President Obama signed the American Tax Relief Act of 2012, temporarily avoiding the fiscal cliff America would have faced had Congress not reached an agreement. The Act addresses both the expiring Bush tax cuts and various spending programs. Overall, the agreement calls for an increase to the top tax bracket rate (now up to 39.6%) for taxpayers with income over $450,000. For all other taxpayers, ordinary income tax rates will remain unchanged. The Act also addresses capital gains rates, qualified dividend rates, and other tax provisions. Although the Act has temporarily resolved issues regarding tax rates, there is still uncertainty about the future of certain budget cuts and the nation’s debt ceiling. This chart compares current tax rates for 2012 to the tax rates for 2013 and beyond.
|Comparing 2012 and 2013 Tax Rates and Figures|
|Income Tax Maximum Rate||35%||39.6%1|
|Alternative Minimum Tax (AMT)Maximum Rate||28%||28%|
|Medicare Tax on Wage Income over $250,000||0%||0.9%|
|Medicare Surtax on Net Investment Income (Applies to Modified Adjusted Gross Income (MAGI) over $200k for Single and $250k for Married Taxpayers)||0%||3.8%|
|Maximum Long Term Capital Gains Rate||15%||20%1|
|Maximum Qualified Dividend Rate||15%||20%1|
|Estate Tax Exemption (Indexed for Inflation)||$5,120,000||$5,250,000|
|Estate Tax Maximum Rate||35%||40%|
|Gift Tax Exemption (Indexed for Inflation)||$5,120,000||$5,250,000|
|Gift Tax Maximum Rate||35%||40%|
|Annual Gift Tax Exclusion (Indexed for Inflation)||$13,000||$14,000|
|Limitation on Itemixed Deductions (For Taxpayers with Adjusted Gross Income (AGI) above $250,000/$300,000)||None||Yes|
|Limitation on Personal and Dependency Exemptions (For Taxpayers with AGI above $250,000/$300,000)||None||Yes|
1Applies to single taxpayers with taxable income over $400,000 and married taxpayers over $450,000
Federal Capital Gains Tax
In 2013, top capital gains rates will permanently rise to 20% for taxpayers with taxable income exceeding $450,000 for joint filers, and $400,000 for single filers. Taxpayers below the 25% tax bracket will continue to pay no tax on capital gains. Taxpayers who are subject to a 25% or greater rate on ordinary income, but whose taxable income falls below the applicable threshold of $450,000 for joint filers and $400,000 for single filers – will continue to be subject to a 15% rate on capital gains. Also, beginning in 2013, a 3.8% surtax will apply to certain unearned investment income exceeding $250,000 for joint filers. This will make the potential maximum federal tax rate for capital gains 23.8%, plus any applicable state tax.
Federal Qualified Dividends Rate
In 2013, an individual’s qualified dividend income will be taxed at the same rates as capital gains, namely 20%, 15%, or 0% depending on what the adjusted capital gain rate is for the taxpayer. Including the Medicare surtax, the potential maximum tax rate for dividends will be 23.8% plus applicable state tax. Please refer to Medicare Surtax below for more information.
A new Medicare surtax went into effect January 1, 2013. Individuals are subject to a tax equal to 3.8% of the lesser of net investment income or the excess of their modified adjusted gross income (MAGI) over a threshold ($200,000 for those filing singly and $250,000 for those filing jointly). Types of income generally included in “net investment income” are interest earnings, dividends, capital gains, annuities, royalties, rents, and all income from a trade or business in which the person does not materially participate.
Alternative Minimum Tax Relief
The Act provides permanent AMT exemption relief and increases exemption amounts under the individual AMT to $50,600 for single filers and $78,750 for married filing jointly. This will begin for the 2012 tax year and the indexes will be adjusted annually for inflation starting in 2013. This will provide greater protection from the AMT, especially for those with large itemized deductions for state and local taxes.
Phase-out of Itemized Deductions and Personal Exemptions
In 2013, an “automatic” tax law rollback will revive the phase-out provisions that existed prior to 2010. For taxpayers whose adjusted gross income (AGI) surpasses certain thresholds, itemized deductions will generally be reduced by 3% of the excess of AGI over the $300,000 ($150,000 for married filing separately) threshold amount until up to 80% of allowable itemized deductions are eliminated. The phase-out of personal exemptions is a reduction of 2% for each $2,500 by which the taxpayer’s AGI exceeds the threshold amount.
IRA Charitable Contributions
The 2012 Act also reinstates a charitable provision often called the “Qualified Charitable Distribution” for 2013. This allows taxpayers who are over age 70 1/2 to withdraw up to $100,000 tax free from an IRA by paying the amount directly to a charity. The IRA distribution is not included in the taxpayers’ gross income and no charitable deduction is reported on their tax return. Taxpayers may also like to take advantage of a retroactive feature, under which transfers made directly to a charity from the IRA before February 1, 2013 can be retroactively applied to the 2012 tax return. Another added provision allows eligible taxpayers who received distributions from an IRA in December 2012 to make a cash contribution to a qualified charity by February 1, 2013 and receive the qualified charitable distribution treatment for 2012.
New Roth Conversion Opportunities
The Act includes new provisions permitting taxpayers to convert traditional retirement accounts like 401(k)s and 403(b)s into designated Roth accounts under the same plan even if they have not reached the age of 59 1/2 or ended their employment. Amounts converted to Roth will be taxable on the date of conversion.
Exclusions for Qualified Small Business Stock (QSBS)
QSBS is stock issued by a C corporation that meets certain requirements, including the requirement that the gross assets of the company do not exceed $50,000,000 at all times prior to stock issuance including immediately after the stock issuance. Taxpayers who purchase QSBS between September 27, 2010 and January 1, 2014, and who hold the stock for at least five years, may exclude up to 100% of the gain from the subsequent sale of the stock. This exclusion also remains a non-preference item for AMT purposes. The exclusion of gain is generally limited to the greater of
i. 10 million of the gain or
ii. Ten times the taxpayer’s cost basis in the stock sold in that year
Investments in QSBS stock made outside the above timeframe are still eligible for the 50% and 75% gain exclusions depending on when the investment was made.
Extensions to Individual Tax Provisions
- Marriage penalty relief: Expanding the size of the 15% tax rate bracket and increased the standard deduction for married taxpayers.
- The Child and dependent care credit: Permanently extended, allowing the credit to be calculated based on $3,000 of expenses for one child and $6,000 expense for more than one.
- Adoption credit and employer-provided adoption assistance program exclusion
- Enhanced rules for student loan deductions
- Higher contribution amount for Coverdell education savings accounts.
- Employer provided child care credit.
- American Opportunity Tax Credit for qualified tuition and other expenses was extended through 2018.
- Deduction of state and local general sales tax
Estate, Gift, and Generation-Skipping Transfer Taxes
The Act permanently extends the estate and gift tax provisions that were in effect in 2012. This includes the gift, estate, and generation-skipping transfer tax exemption amount of $5 million per person, indexed for inflation for the years after 2011. The ability to transfer any unused exemption to a surviving spouse at death remains intact as well. The top rate changes from 35% to 40% effective January 1, 2013.
Business Tax Provisions
- The additional 50% first-year depreciation deduction for investment in “qualified property” is extended for property placed into service in 2013. The Act also allows corporations to elect to take additional AMT credits in 2013 if they agree to forego the use of bonus depreciation on qualified property placed into service in those years and to depreciate such property using the straight-line method.
- The limitation on the amount of Section 179 expensing is increased to $500,000 for tax years beginning in 2013 with a phase-out beginning when the amount exceeds $2 million.
- There is a 15 year write-off for qualified leasehold improvements, restaurant buildings and improvements, and retail improvements is extended through December 31, 2013.
Extensions of Other General Business Provisions
- The Research and Development credit is reinstated retroactively, from January 1, 2012 to December 31, 2013.
- The Work Opportunity Tax credit is extended for individuals who work for the employer prior to January 1, 2014.
- The reduction in the S corporation recognition period for built-in-gains is extended through 2013, with a five-year recognition period rather than ten years.
- The subpart F exception for active financing income is extended.
- Empowerment zone tax incentives have been reinstated and extended through December 31, 2013.
Any tax advice in this communication is not intended or written by Frank, Rimerman + Co. LLP to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer, or (ii) promoting, marketing, or recommending to another party any matters addressed herein. With this alert, Frank, Rimerman + Co. LLP is not rendering any specific advice to the reader.