ElectroFile Income Tax Service   Income Tax Service   Terry Hough, President
Terry Hough

The American Taxpayer Relief Act of 2012

During the waning hours of 2012 and early into Jan. 1, 2013, Congress and the White House worked to avert the so-called fiscal cliff that was due to strike on the first of the New Year. The result of these efforts is The American Taxpayer Relief Act of 2012 (the Act). This new tax law does several things relating to the fiscal cliff including a deferral of sequestration. Sequestration is the set of mandatory across the board spending cuts that were to take effect Jan. 1. As a result of the Act, these spending cuts have been deferred until March when once again the Congress and the White House will have to address them.

Following is a summary of the more significant tax changes effected by the Act.

Individual tax rates

Under the Act, the tax rates for individuals will generally remain at 2012 levels. The lowest tax rate of 10 percent was schedule to rise to 15 percent on Jan. 1, but will remain at 10 percent for years after 2012. As well, the 25 percent, 28 percent, 33 percent and 35 percent rates were scheduled to rise to 28 percent, 31 percent, 36 percent and 39.6 percent, but will remain at the lower rates for years after 2012. This extension of the lower rates applies to individual taxpayers making less than $400,000, $425,000 if filing as head-of-household, and married couples making less than $450,000 ($225,000 for each married spouse filing separately). Note that under the Act, these rates are made permanent.

The new top rate of 39.6 percent applies to taxable income over $400,000 for single filers, $425,000 if filing as head-of-household, and $450,000 for married taxpayers filing jointly ($225,000 for each married spouse filing separately).

Capital gains and dividends

Under the Act, a 20 percent rate applies to capital gains and dividends for taxpayers who are taxed at the 39.6 percent rate; the 15 percent rate continues for taxpayers in the 25 percent, 28 percent, 33 percent and 35 percent brackets. With respect to taxpayers in the 10 and 15 percent brackets, the 0 percent rate remains.

Personal exemptions and itemized deductions

Under current law taxpayers have to phase out their personal exemptions at certain income levels. The Act permanently eliminates this phase-out for individuals making less than $250,000, $275,000 for heads of household, and married couples making less than $300,000 ($150,000 for married spouses filing separately).

In addition, current law limits the amount of itemized deductions that certain taxpayers are allowed to claim. The Act permanently eliminates these limitations for individuals making less than $250,000, heads of household earning less than $275,000, and married couples making less than $300,000 ($150,000 for married spouses filing separately).

Payroll tax matters

One issue not addressed in the Act is the payroll tax relief that has been in effect for the past few years. This means that as of Jan. 1, 2013, all working Americans who contribute to the Social Security system will see their payroll tax on the first $113,700 of wages increase from the current 4.2 percent to 6.2 percent. Similarly, the additional 0.9 percent Medicare tax for individuals making more than $200,000 (married couples making more than $250,000) also goes into effect on Jan. 1. There are corresponding increases for individuals who are subject to self-employment tax.

Alternative minimum tax

The Act permanently indexes the individual alternative minimum tax (AMT) exemption amount for inflation. For 2012, the exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers.

Pursuant to the Economic Growth and Relief Reconciliation Act of 2001, prior law granted relief from the AMT for nonrefundable credits; this relief is retained under the Act.

Estate and gift tax laws are made permanent

Under the new 2013 federal agreement, U.S. estate tax law will permanently extend the $5.12 million per person lifetime exemption. The policy of unifying the estate and gift taxes continues; that is, the $5.12 million lifetime exemption is available for both accumulated taxable gifts and estates. The $5.12 million exemption will be indexed for inflation.

The maximum estate and gift tax rate has risen from 35 to 40 percent. However, all other current tax policies will remain in place. This is of utmost importance since a key Democratic proposal was to curtail dramatically the use of valuation discounts on related party transactions, extend the minimum term of grantor retained annuity trusts (GRATs) to 10 years, and eliminate the income and gift tax benefits related to sales or gifts to intentionally defective grantor trusts (IDGTs). In essence, the sophisticated estate and business succession strategies that have been historically available to the high net worth taxpayer appear to be maintained.

Finally, the agreement makes permanent the portability of the deceased spouse’s $5.12 million lifetime exclusion. The executor’s ability to transfer any unused lifetime exemption of a deceased spouse’s estate to the surviving spouse is effective for estates of decedents dying after Dec. 31, 2010.

After a decade of tax ambiguity, the new agreement restores certainty to the estate and gift tax policy as well as providing clarity for estate and financial planners to execute viable estate and gift tax plans that can be relied upon over the next few years.

Numerous expiring tax provisions extended

A large part of the uncertainty faced by businesses and individual taxpayers alike was the fate of the so-called extenders; expiring tax provisions that must be renewed by new enacting legislation every one to two years. Many of these extenders are tax credits and incentives that are a major component of the economic analysis that drives business decisions. The uncertainty surrounding extenders has slowed investment in research and development, capital expenditures and renewable energy projects among other economic activities. Among the more notable extended provisions are the following:

Individual Tax Provisions Expired On Extension Period
Deduction for certain expenses of elementary and secondary school teachers 12/31/11 2012 and 2013
Treatment of mortgage insurance premiums as qualified residence interest 12/31/11 2012 and 2013
Option to deduct state and local general sales taxes in lieu of income taxes 12/31/11 2012 and 2013
Above-the-line deduction for qualified tuition and related expenses 12/31/11 2012 and 2013
Tax-free distributions from individual retirement plans for charitable purposes 12/31/11 2012 and 2013

Business Tax Provisions Expired On Extension Period
50% bonus depreciation 12/31/12 2013
50% bonus depreciation for certain long-lived and transportation property 12/31/13 2014
Decoupling of bonus depreciation claimed from allocation of long-term contract costs under the percentage-of-completion method for assets with a MACRS recovery period of seven years or less 12/31/10 2013 only
Election to claim AMT credits in lieu of bonus depreciation 12/31/12 2013
Seven-year recovery period for motorsports entertainment complexes 12/31/11 2012 and 2013
15-year straight line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements 12/31/11 2012 and 2013
Increased expensing limitations ($500,000 maximum amount and $2 million phase-out threshold) and treatment of certain real property as section 179 property 12/31/11 2012 and 2013
Shorten from 10-year to five-year built-in gain recognition period for S corporations 12/31/11 2012 and 2013
Section 41 research and development tax credit 12/31/11 2012 and 2013

Energy Tax Provisions Expired On Extension Period
Section 25C nonbusiness energy property credit for energy-efficient existing homes: 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) 12/31/11 2012 and 2013
Section 30C alternative fuel vehicle refueling property credit, which includes a 30% credit for electric car charging stations up to $30,000 12/31/11 2012 and 2013
Section 40(b) cellulosic biofuel producer credit 12/31/12 2013
Section 40A biodiesel and renewable diesel 12/31/11 2012 and 2013
Section 45 wind energy production tax credit 12/31/12 2013
Section 45L energy efficient new homes credit 12/31/11 2012 and 2013

IRA provisions

The Act extended the $100,000 charitable rollover provision for IRAs through 2013. In addition, a taxpayer is permitted to treat a rollover during January of 2013 to as a 2012 rollover. Also, taxpayers who took an IRA distribution in December 2012 will be able to contribute any portion of that amount to a charity and count it as an eligible charitable rollover; however, it must otherwise meet the requirements for an eligible charitable rollover.

The Act also made most of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) tax changes permanent, with the result that the contribution limit for Coverdell Education Savings Accounts will remain at $2,000 instead of reverting to the pre-EGTRRA $500 limit.

In addition, the Act amended the provisions applicable to 401(k), 403(b) and government 457(b) plans as well as the Federal Thrift Savings Plan to permit, effective Jan. 1, 2013, participants in those plans to convert their existing pre-tax deferral accounts into Roth accounts. Before this change in the law, a participant would have had to have attained age 59 ½ or otherwise be entitled to a distribution of his/her elective deferral account to make such a Roth conversion election. With respect to plans other than the Federal Thrift Savings Plan, plan sponsors will need to decide whether or not to amend their plans for participants with this option. If an election is made to convert a pre-tax deferred account into a Roth account, that conversion is fully taxable in the year of the conversion.

Health care related changes

Under the Act, the substantial Medicare reimbursements cuts that physicians were facing in 2013 have been delayed until 2014. However, the Act does many targeted reduction in payments to hospitals, certain physicians and other medical service and supply providers.

The Act repeals the already suspended Community Living Assistance Services and Supports program that was originally enacted as a part of the Affordable Care Act. The Act, however, does establish a new Long Term Care Commission that is charged with the developing a plan for the establishment, implementation and financing of a comprehensive, coordinated and high quality system of long term care in the United States.

Treatment of carried interest unchanged

Notably, the Act does not include any changes to the controversial treatment of "carried interest." Carried interest generally refers to the ability of private equity and hedge fund managers to hold profits interests in the fund and to be compensated for their managerial activities with a percentage of the favorably taxed long-term capital gains (or qualified dividends) earned by the fund. If the same amounts of compensation were structured as additional salary tied to the performance of the fund, like a bonus or incentive compensation arrangement, that amount would be taxed as ordinary income, and the fund owners that acquired their interests for cash (rather than for services) would obtain a deduction for that salary or fee expense. The proper tax treatment of this item has been debated in the past, and under the Act, remains unchanged.

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All information provided is general in nature and intended to create awareness, not to address the specific circumstances or concerns of any individual or entity. Although we try to provide correct and timely information, we cannot guarantee the accuracy of any information or that such information will continue to be accurate in the future due to the changing nature of the tax laws. Before acting on any of the information provided here, you should consult with a professional advisor who knows all of the unique facts and circumstances pertinent to your particular situation.