Now We Know What The Rules Are | Tax Tip of the Week | No. 183

Highlights of the Individual Tax Provisions in the New Taxpayer Relief Act

After months of senseless haggling, the Senate, early in the morning of Jan. 1, 2013, by a vote of 89–8, and the House of Representatives, late in the evening of Jan. 1, by a vote of 257–167, passed the American Taxpayer Relief Act of 2012, P.L. 112-240 (the Act). On Jan. 2, President Barack Obama signed the act into law, thereby avoiding the “fiscal cliff.” What was left on the table after the deal, which will set up another prolonged battle that will reinforce the divisiveness that has plagued Congress, are spending cuts, the budget, and the debt ceiling, not to mention basic tax reform.General provisionsThe most significant provisions of the Act made the Bush tax cuts permanent for married taxpayers filing jointly and surviving spouses with taxable incomes up to $450,000, for taxpayers filing single with taxable incomes of up to $400,000, and for taxpayers filing as heads of households with taxable incomes up to $425,000. The Act imposed a 39.6% rate on taxable income above those thresholds; extended the 15% rate on dividends and long-term capital gains for taxpayers under those threshold levels; and imposed a 20% rate on long-term capital gains and qualified dividends for taxpayers to the extent their income is above those thresholds.The Act returned the personal exemption phase-out and a limitation on itemized deductions that had been repealed when the Bush tax cuts were enacted, and permanently indexed the AMT individual exemption amounts for inflation. Furthermore, the Act extended a variety of previously extended temporary tax provisions set to expire, commonly referred to as “tax extenders,” which affect individuals, businesses, charitable giving, energy, community development, and disaster relief.The Act also made permanent a top estate tax rate of 40% and an estate tax exclusion of $5 million (indexed for inflation) for estates of decedents dying after Dec. 31, 2012. The $5 million estate tax exclusion was coordinated with the gift tax and the generation-skipping transfer tax so that the same $5 million exclusion applies to all three taxes.Most disappointingly, Congress allowed the 2% payroll tax cut to expire at the end of 2012, resulting in a tax increase to about 114 million taxpayers, especially middle-class and lower-income taxpayers who have more of their income subject to the payroll tax.Individual income tax ratesIn addition to the rate changes and income thresholds discussed above, all of the tax brackets and the threshold amounts are to be adjusted for inflation after 2013 based upon the standard formula, not the chained formula that considers changes in consumer buying habits as a result of increased prices, which would result in lower increases.In addition, starting in 2013, the 0.9% Medicare surtax applies to wage income greater than $200,000 for single taxpayers filing individual returns and $250,000 for married taxpayers filing joint returns. This tax was enacted in 2010 as part of health care reform (Patient Protection and Affordable Care Act, P.L. 111-148, as amended by the Health Care and Education Reconciliation Act of 2010, P.L. 111-152 (the health care acts).Capital gains/dividend tax ratesTo the extent that a taxpayer’s taxable income exceeds the threshold amounts for the 39.6% tax rate, long-term capital gains and qualified dividends will be subject to a 20% rate, an increase from the Bush-era maximum rate of 15%. Capital gains and qualified dividends that would be subject to the 25% through 35% rates if they were ordinary income will continue to be subject to a 15% capital gains rate. A 0% rate will continue to apply to capital gains and qualified dividends that would be taxed at the 15% rate if they were ordinary income. For 2013, ordinary income below $72,500 for joint filers and $36,250 for single filers will be taxed at the 15% rate.Under another provision from the health care acts that was not affected by the latest legislation,  which applies starting in 2013, taxpayers filing single returns whose adjusted gross income (AGI) exceeds $200,000 and married taxpayers filing joint returns whose AGI exceeds $250,000 are subject to an additional 3.8% tax on net investment income.Alternative minimum tax reliefEnding the yearly drama of enacting an alternative minimum tax (AMT) patch, the Act patches the AMT for 2012 and subsequent years by increasing the exemption amount subject to an annual inflation adjustment and allowing nonrefundable personal credits to offset in full regular taxes and AMT. For 2012, the Act increased the exemption amount to $50,600 from $33,750 for taxpayers filing individual returns and to $78,750 from $45,000 for married taxpayers filing joint returns. For 2013, the inflation-adjusted amounts are $51,900 for single taxpayers and $80,800 for married taxpayers filing joint returns.The continued existence of the AMT is uncertain if Congress tackles comprehensive tax reform. In addition, President Obama has proposed replacing the AMT with the so-called Buffett Rule, under which taxpayers making more than $1 million would pay an effective rate of 30%.Itemized deduction limitationThe Act has reinstated the Pease limitation (named after the congressman who sponsored the original provision) to reduce itemized deductions for taxpayers who meet certain thresholds by 3% of the amount by which the taxpayer’s AGI exceeds the thresholds.  The threshold amount is $250,000 for single taxpayers and $300,000 for married taxpayers filing joint returns. These thresholds are subject to adjustment for inflation for tax years after 2013. Under the Pease limitation, the amount of itemized deductions cannot be reduced by more than 80%.Personal exemption phase-outThe phase-out of personal exemptions for taxpayers whose income is above certain threshold amounts was repealed for 2010, and the repeal was extended through 2012. The Act reinstates the phase-out of personal exemptions for taxpayers whose AGI exceeds the threshold amounts applicable to the Pease limitation. Under the Act, the total amount of exemptions that may be claimed by a taxpayer is reduced by 2% for each $2,500 by which the taxpayer’s AGI exceeds the applicable threshold amount, e.g., $250,000 for single taxpayers and $300,000 for married taxpayers filing joint returns.Marriage penalty reliefThe Act extended all marriage penalty relief. It kept the standard deduction for married taxpayers filing joint returns at twice the standard deduction for taxpayers filing individual returns, rather than allowing it to fall to 167% of the standard deduction for taxpayers filing individual returns. It also kept the 15% bracket for married taxpayers filing joint returns at 200% of the corresponding tax bracket for taxpayers filing individual returns. However, in the other areas of the Act dealing with threshold levels, Congress made no effort to extend marriage penalty relief.

MiscellaneousThe Act extends for five years certain tax breaks for low- and middle-income taxpayers, such as the earned income tax credit, the child tax credit, and the American opportunity tax credit. In addition, the Act extends through 2013 the deduction of up to $250 for certain expenses incurred by elementary and secondary school teachers; the exclusion from income for discharge of qualified principal residence indebtedness; the treatment of mortgage insurance premiums as qualified residence interest; the option to deduct state and local general sales taxes; the above-the-line deduction for qualified tuition and related expenses; and the exemption for 100% of the gain on sales of certain small business stock.  As always, give us a call with any questions or concerns you may have. 

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Rick Prewitt - the guy behind TTW...until next week.