After much contention and negotiation, President Obama and Congress finally came to agreement on legislation to address the tax side of the “fiscal cliff.” Early on Jan. 1, 2013, the Senate by a vote of 89 to 8 approved H.R. 8, The American Taxpayer Relief Act (“ATRA”). That evening, the House of Representatives followed suit and passed the bill by a vote of 257 to 167. The president is expected to quickly sign and enact the bill into law. The major thrust of the legislation allows the Bush-era tax rates to sunset for individuals with income over $400,000 and families with income over $450,000. The key provisions affecting businesses and individuals are as follows:
Major tax provisions affecting businesses
Businesses will benefit from the extension of various tax breaks. These include:
- Bonus depreciation
- Enhanced Section 179 expensing
- Accelerated depreciation for qualified leasehold, retail and restaurant improvements
- The Work Opportunity credit
- The Research and Development credit, including the extension of certain energy-related breaks
Major tax provisions affecting individuals
Many of the tax provisions in ATRA affect individual taxpayers. These include:
- The income tax rate increases to 39.6% (up from 35%) for individuals making more than $400,000 a year ($450,000 for joint filers; $225,000 for married filing separate; $425,000 for heads of household).
- No provision has been made to extend the two-percentage-point reduction in payroll taxes for employees, commonly known as payroll tax relief; thus, it will be allowed to expire.
- The alternative minimum tax (AMT) patch is made permanent, resulting in an estimated 30 million taxpayers escaping being subject to the AMT.
- Dividends and long term capital gains are taxed at 20% (up from 15%) for individuals making at least $400,000 ($450,000 for joint filers; $225,000 for married filing separate; $425,000 for heads of household). Thus, the feared increase of tax rates applicable to dividends rising to 39.6% has been avoided. The phase out itemized deductions and personal exemptions are both reinstated with a threshold of $250,000 for single filers, $300,000 for joint filers, $150,000 for married filing separate and $275,000 for heads of household. Under these two items, taxpayers with income above the threshold will see their itemized deductions and personal exemptions limited.
- A number of individual tax provisions have been retroactively extended through 2013 such as:
- The American Opportunity Tax Credit for qualified tuition expenses.
- 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 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.
- Tax-free distributions for individuals age 70 ½ or older up to $100,000 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.
Major tax provisions related to the Estate Tax
Under ATRA, the Estate, Gift and Generation Skipping Transfer (GST) exemption amount will continue to be an annually inflation-adjusted $5 million per person. For 2013, the exemption amount will likely increase slightly from the $5.12 million exemption available in 2012. Also for 2013 and future years, the maximum tax rate will be 40%. The gift and estate exemptions are unified which means each individual has a $5 million exemption to use during lifetime by gifting or at death.
The Act also makes “portability” of a spouse’s unused exemption permanent, effectively giving a married couple the ability to pass $10 million estate tax free. Surviving spouses will be able to use any unused exemption of the pre-deceasing spouse as long as the proper election is made.
There are many other tax related provisions that will be expanded on in future Tax Alerts. At this time, we are waiting for further details on all the tax related provisions. As always, the “devil is in the detail.” If you have any questions on how this bill will affect you and your business, please contact your Warren Averett adviser.