On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012, averting the “Fiscal Cliff.” Although the Act has far too many provisions for us to include in a blog posting, we wanted to share with you our understanding regarding some key elements of the legislation.
For many taxpayers, the most important changes in the “New Year’s Day” Act are those having to do with marginal income tax rates, the AMT, the tax rates on dividends and capital gains and related income tax changes.
The current income tax rates, often referred to as the Bush-era tax rates, remain unchanged except for individuals with income over $400,000 and families with incomes over $450,000. Those individuals are now subject to a 39.6% marginal tax rate. These taxpayers will still enjoy the Bush-era rates for income below these thresholds.
A 20% rate applies to capital gains and dividends for taxpayers above the aforementioned top income tax bracket thresholds; the 15% rate is retained for taxpayers in lower brackets. The zero rate is retained for taxpayers in the 10% and 15% brackets. Qualified dividends will continue to be taxed at capital gains rates rather than being taxed at ordinary rates.
Taxpayers with AGIs of $250,000 for single taxpayers, $275,000 for heads of household, and $300,000 for married taxpayers filing jointly will find their itemized deductions and personal exemptions phased out. In addition, the threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.
The alternative minimum tax (AMT) (“patch”) exemption amount was made permanent. In addition, it was indexed for inflation. This will protect 30 million taxpayers from the AMT liability. For 2012, the exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers. Relief from AMT for nonrefundable credits is retained.
In addition to an extension for most taxpayers of the lower individual income and capital gains tax rates, the marriage penalty relief being made permanent, and more than 50 other tax benefits popularly referred to as the “Bush Tax Cuts,” the legislation makes over 100 changes to the Internal Revenue Code. One such change was that the Act extended through 2013 a number of energy credits and provisions that expired at the end of 2011.
The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of SECA tax on self-employment income in excess of the threshold amount.
Starting Jan. 1, a new tax is imposed on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (AGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins. For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is $125,000; and for other individuals it is $200,000. See our August 27, 2012 posting regarding the 3.8% tax.
Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.
The Act, at least with regard to the estate tax, gift tax and GST provisions, made “permanent” the 2012 laws, with only a few important changes. The $5,120,000 estate tax, gift tax and GST exemption was retained and will be inflation adjusted, which for 2013 means that those exemptions will be $5,250,000, an increase of $130,000 over the 2012 exemptions. However, the tax rate on estates, gifts and GST transfers above the exemption was increased to 40%, from the 35% rate in effect in 2012.
The so-called “portability” or transferability rules that simplify the use of the estate and gift tax exemptions for married taxpayers was scheduled to expire in 2013. The New Year’s Day Act made the portability rules permanent. This allows the transfer to the surviving spouse of the unused tax exemption of the first spouse to die.
The “annual exclusion amount” for gift tax purposes will be $14,000 in 2013, an inflation-adjusted increase of $1,000 from 2012. This is the maximum amount that an individual can gift to a beneficiary in a calendar year without using gift tax exemption or paying gift tax (subject to exceptions for gifts to a spouse or charity, or the direct payment of tuition or medical expenses).
Although most of the changes made to extend the Bush tax cuts and the other provisions are welcomed by most taxpayers, as we know from past history there is no way to know whether or when these taxes will be revised again in the future. We are all aware that the federal debt limit will require continued negotiations in Washington and the federal deficit will need to be addressed.
Among the tax items not addressed by the Act was the temporary lower 4.2% rate for employees’ portion of the Social Security payroll tax, which was not extended and has reverted to 6.2%. Thus for most working Americans, their paycheck take-home pay will decrease.
Please be sure to read the disclaimer page on our blog. This blog is for educational purposes only and should not be considered as the rendering of tax advice.
