In the early morning hours of January 1, 2013, as many of us were making jubilant phone calls and firing poorly spelled text messages to close friends and relatives, the US Senate ushered in the New Year by passing H.R. 8, the “American Taxpayer Relief Act” (the Act), by a vote of 89-8. Later in the day, after the country had technically gone over the “fiscal cliff,” the House of Representatives also voted to pass the bill by a 257 to 167 vote. The Act, which the president is expected to quickly sign into law, would prevent many of the tax hikes that were scheduled to go into effect this year and retain many favorable tax breaks that were scheduled to expire. However, it would also increase income taxes for some high-income individuals and slightly increase transfer tax rates.
This blog will outline the Act’s key provisions that we have identified upon our first read of the new legislation. However, since we are still digesting all of the information and expect additional clarifications and interpretations to surface during the next few days, we will be updating this post regularly to keep you up to date on one of the most significant pieces of tax legislation in the last century. It may help to review the Internal Revenue Code sections referenced in this blog as these are highly technical tax changes.
Highlights of the Act include the following:
For tax years beginning after 2012, the income tax rates for individuals will stay at 10%, 15%, 25%, 28%, 33% and 35% (instead of moving to 15%, 28%, 31%, 36% and 39.6% as would have occurred under the EGTRRA sunset), but with a 39.6% rate applying for income above a certain threshold (specifically, income in excess of the “applicable threshold” over the dollar amount at which the 35% bracket begins). The applicable threshold is $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. These dollar amounts are inflation-adjusted for tax years after 2013.
Capital gain and dividend rates rise for higher-income taxpayers
For tax years beginning after 2012, the top rate for capital gains and dividends will permanently rise to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When accounting for Code Sec. 1411's 3.8% surtax on investment-type income and gains for tax years beginning after 2012, the overall rate for higher-income taxpayers will be 23.8%. (Under the EGTRRA/JGTRRA sunset provisions, long-term capital gain was to be taxed at a maximum rate of 20%, with an 18% rate for assets held more than five years, and dividends paid to individuals were to be taxed at the same rates that apply to ordinary income.)
Pease limitations to apply to “high-earners”
For tax years beginning after 2012, the “Pease“ limitation on itemized deductions, which had previously been suspended, is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer's adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013.
PEP limitations to apply to “high-earners”
For tax years beginning after 2012, the Personal Exemption Phaseout (PEP), which had previously been suspended, is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. These dollar amounts are inflation-adjusted for tax years after 2013.
Permanent AMT relief
The Act provides permanent alternative minimum tax (AMT) relief. The AMT is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%.
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 Act 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.
Prior to the Act, for 2012, nonrefundable personal credits—other than the adoption credit, the child credit, the savers' credit, the residential energy efficient property credit, the non-depreciable property portions of the alternative motor vehicle credit, the qualified plug-in electric vehicle credit, and the new qualified plug-in electric drive motor vehicle credit—were to be allowed only to the extent that the individual's regular income tax liability exceeded his tentative minimum tax, determined without regard to the minimum tax foreign tax credit. Retroactively effective for tax years beginning after 2011, the Act permanently allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits.
Transfer tax provisions kept intact with slight rate increase
The Act 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 Act also permanently increases the top estate, gift and rate from 35% to 40%. The Act 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.
For transfers after Dec. 31, 2012, in tax years ending after that date, plan provisions in an applicable retirement plan (which includes a qualified Roth contribution program) can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution under Code Sec. 408A(e).
Recovery Act extenders
The Act extends for five years the following items that were originally enacted as part of the American Recovery and Investment Tax Act of 2009 and that were slated to expired at the end of 2012:
- The American Opportunity tax credit, which permits eligible taxpayers to claim a credit equal to 100% of the first $2,000 of qualified tuition and related expenses, and 25% of the next $2,000 of qualified tuition and related expenses (for a maximum tax credit of $2,500 for the first four years of post-secondary education);
- Eased rules for qualifying for the refundable child credit; and
- Various earned income tax credit (EITC) changes relating to higher EITC amounts for eligible taxpayers with three or more children, and increases in threshold phaseout amounts for singles, surviving spouses, and heads of households.
Historical individual extenders
The Act extends the following items for the period indicated beyond their prior termination date as shown in the listing:
- 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;
- Parity for the exclusions for employer-provided mass transit and parking benefits, which applied before 2012 and which is now revived for 2012 and continued through 2013;
- 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 is revived for 2012 and continued through 2013. Because 2012 has already passed, a special rule permits distributions taken in December of 2012 and transferred to charities until January 31, 2013 to qualify. Another special rule permits distributions made in January of 2013 as being deemed made on December 31, 2012. This allows those who did not receive a distribution in December of 2012 an opportunity to take advantage of the law on their 2012 tax returns if they accelerate their 2013 distributions into January. These distributions must also be transferred to charities by January 31st. Additionally, only IRA owners 70 ½ and older can qualify.
Depreciation provisions modified and extended
The following depreciation provisions are retroactively extended by the Act through 2014:
- 15-year straight line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements;
- 7-year recovery period for motorsports entertainment complexes;
- Accelerated depreciation for business property on an Indian reservation;
- Increased expensing limitations and treatment of certain real property as Code Sec. 179 property;
- Special expensing rules for certain film and television productions; and
- The election to expense mine safety equipment.
The Act also extends and modifies the bonus depreciation provisions with respect to property placed in service after Dec. 31, 2012, in tax years ending after that date.
Business Tax Breaks and Energy-Efficient Tax Breaks Extended
Due to the voluminous nature of these extensions we have included them in a separate Business & Energy-Efficient Tax Break Extensions document that can be found by clicking the link.
The Tax Warriors at Drucker & Scaccetti look forward to further analyzing and dissecting the new legislation in the coming days and will be sure to keep you updated! As always, we welcome your comments below and encourage you to “Ask a Tax Warrior” if you have specific questions for our experts here.