The recently enacted 2012 American Taxpayer Relief Act includes a wide-ranging assortment of tax changes affecting both individuals and business. The sweeping tax package includes, among many other items, permanent extension of the Bush-era tax cuts for most taxpayers, revised tax rates on ordinary and capital gain income for high-income individuals, modification of the estate tax, permanent relief from the alternative minimum tax (AMT) for individual taxpayers, limits on the deductions and exemptions of high-income individuals, and a host of retroactively resuscitated and extended tax breaks for individual and businesses. Here’s a look at the key elements of the package:
- Tax rates.
For tax years beginning after 2012, the 10%, 15%, 25%, 28%, 33% and 35% tax brackets from the Bush tax cuts will remain in place and are made permanent. This means that, for most Americans, the tax rates will stay the same. However, there will be a new 39.6% rate, which will begin at the following thresholds: $400,000 (single), $425,000 (head of household), $450,000 (joint filers and qualifying widow(er)s), and $225,000 (married filing separately). These dollar amounts will be inflation-adjusted for tax years after 2013.
- Estate tax.
The new law prevents steep increases in estate, gift and generation-skipping transfer (GST) tax that were slated to occur for individuals dying and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation). However, the new law also permanently increases the top estate, gift, and GST rate from 35% to 40%. It also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion to the surviving spouse. All changes are effective for individuals dying and gifts made after 2012.
- Capital gains and qualified dividends rates.
The new law retains the 0% tax rate on long-term capital gains and qualified dividends, modifies the 15% rate, and establishes a new 20% rate. Beginning in 2013, the rate will be 0% if income falls below the 25% tax bracket; 15% if income falls at or above the 25% tax bracket but below the new 39.6% rate; and 20% if income falls in the 39.6% tax bracket. It should be noted that the 20% top rate does not include the new 3.8% surtax on investment-type income and gains for tax years beginning after 2012, which applies on investment income above $200,000 (single) and $250,000 (joint filers) in adjusted gross income. So actually, the top rate for capital gains and dividends beginning in 2013 will be 23.8% if income falls in the 39.6% tax bracket. For lower income levels, the tax will be 0%, 15%, or 18.8%.
- Personal exemption phaseout.
Beginning in 2013, personal exemptions will be phased out (i.e., reduced) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). Taxpayers claim exemptions for themselves, their spouses and their dependents. Last year, each exemption was worth $3,800.
- Itemized deduction limitation.
Beginning in 2013, itemized deductions will be limited for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers).
- AMT relief.
The new law provides permanent AMT relief. Prior to the Act, the individual AMT exemption amounts for 2012 were to have been $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for married persons filing separately. Retroactively effective for tax years beginning after 2011, the new law permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, it indexes these exemption amounts for inflation.
- Tax credits for low to middle wage earners.
The new law extends for five years the following items that were originally enacted as part of the 2009 stimulus package and were slated to expire at the end of 2012: (1) the American Opportunity tax credit, which provides up to $2,500 in refundable tax credits for undergraduate college education; (2) eased rules for qualifying for the refundable child credit; and (3) various earned income tax credit (EITC) changes.
- Section 179 expensing.
The new law extends increased expensing limitations and treatment of certain real property as Code Section 179 property. The new law makes three important changes to the Code Section 179 expense election. First, the new law provides that for tax years beginning in 2012 or 2013, a small business taxpayer will be allowed to write off 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 beginning after 2013, the maximum expensing amount will drop to $25,000 and the phaseout level will drop to $200,000. Second, the new law extends the rule which treats off-the-shelf computer software as qualifying property through 2013. Finally, the new law extends through 2013 the provision permitting a taxpayer to amend or irrevocably revoke an election for a tax year under Section 179 without IRS’s consent.
- Additional first-year (bonus) 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 fist-year write-off of the cost. For qualified property acquired and placed in service after Dec. 31, 2011 and before Jan. 1, 2013 (before Jan. 1, 2014 for certain longer-lived and transportation property), the additional first-year depreciation was 50% of the cost. The new law extends this additional first-year depreciation for investments placed in service before Jan. 1, 2014 (before Jan. 1, 2015 for certain longer-lived and transportation property). The new law also extends for one year the election to accelerate the AMT credit instead of claiming additional first-year depreciation. The new law leaves in place the existing rules as to what kinds of property qualify for additional first-year depreciation. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; or (4) qualified leasehold improvements. Also the original use of the property must commence with the taxpayer – used machinery doesn’t qualify.
- Tax break extenders.
Many of the “traditional” tax extenders are extended for two years, retroactively to 2012 and through the end of 2013. Among many others, the extended provisions include:
- … the deduction for certain expenses of elementary and secondary school teachers, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
- … the exclusion for discharge of qualified principal residence indebtedness, which applied for discharges before Jan. 1, 2013 and which is now continued to apply for discharges before Jan. 1, 2014;
- … the treatment of mortgage insurance premiums as qualified residence interest, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
- … the option to deduct State and local general sales taxes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
- … the special rule for contributions of capital gain real property made for conservation purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
- … the above-the-line deduction for qualified tuition and related expenses, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013; and
- … tax-free distributions from individual retirement plans for charitable purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013. Because 2012 has already passed, a special rule permits distributions taken in 2012 to be transferred to charities for a limited period in 2013. Another special rule permits certain distributions made in 2013 as being deemed made on Dec. 31, 2012.
- Pension provision.
The new provision permits individuals to convert any portion of their balance in an employer-sponsored tax-deferred retirement plan account into a Roth account under that plan. The catch under the new law conversion provision, and it’s a big one, is that the conversion will be fully taxed, assuming the conversion is being made with pre-tax dollars (money that wasn’t taxed to an employee when contributed to the qualified employer-sponsored retirement plan) and the earnings on those pre-tax dollars. For example, a taxpayer in the 28% federal tax bracket who converted $100,000 from an employer-sponsored plan funded entirely with deductible dollars to a Roth IRA would owe $28,000 of tax. So, in deciding whether to pursue a Roth conversion, one would need to weigh the price of paying tax now against the advantages afforded by future tax-free withdrawals and freedom from the RMD rules. The conversion option for retirement plans would only be available if employer plan sponsors include this feature in the plan. The provision is effective for post-2012 transfers, in taxable years ending after Dec. 31, 2012.
- Energy-related tax breaks.
The Act extends a host of important energy-related tax breaks for individuals and businesses. The various energy credits extended include:
- The nonbusiness energy property credit for energy-efficient existing homes is retroactively extended for two years through 2013. A taxpayer can claim a 10% credit on the cost of: (1) qualified energy efficiency improvements , and (2) residential energy property expenditures, with a lifetime credit limit of $500 ($200 for windows and skylights).
- The credit for energy-efficient new homes is retroactively extended for two years through 2013.
- The credit for energy-efficient appliances is retroactively extended for two years through 2013.
- Payroll tax cut is no more.
The 2% payroll tax cut was allowed to expire at the end of 2012.
We hope this information is helpful. If you would like more details about these provisions or any other aspect of the new law, please do not hesitate to call.