Highlights of the American Taxpayer Relief Act – Part I
On January 1, 2013, Congress passed the American Taxpayer Relief Act (“2012 Taxpayer Relief Act”), which the President has vowed to sign as soon as it is ready for his signature. The 2012 Taxpayer Relief Act will prevent many of the tax hikes scheduled to go into effect this year and retain many favorable tax breaks that were scheduled to expire. The 2012 Taxpayer Relief Act also increases income taxes for some “high-income” individuals, modifies the 2012 transfer tax rates slightly, and extends a host of expired and expiring tax breaks for businesses and individuals. Here are a few highlights of the new legislation. We will provide additional information regarding other provisions of the new legislation in the coming days.
Estate, Gift and Generation Skipping Transfer Tax Provisions Kept Mostly Intact
The 2012 Taxpayer Relief 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 unified exemption level at $5,000,000 (currently $5,120,000 as indexed for inflation). However, the 2012 Taxpayer Relief Act also permanently increases the top estate, gift and GST tax rate from 35% to 40%. The 2012 Taxpayer Relief Act also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion amount to the surviving spouse.
Individual Income Tax Rates
For tax years beginning January 1, 2013, the income tax rates for most 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 if current tax rates had been allowed to expire). However, a 39.6% tax rate now applies to income exceeding $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married individuals filing seperately. These dollar amounts are inflation-adjusted for tax years after 2013.
Capital Gain and Dividend Rates
For tax years beginning January 1, 2013, the top rate for long-term capital gains and qualified dividends will permanently rise to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When accounting for I.R.C. § 1411’s 3.8% surtax on investment-type income and gains for tax years beginning January 1, 2013, the overall rate for higher-income taxpayers will be 23.8% on both long-term capital gains and qualified dividends.
For taxpayers whose ordinary income is generally taxed at a rate below 25%, long-term capital gains and qualified dividends will permanently be subject to a 0% rate. Taxpayers who are subject to a 25% or greater tax rate on their ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on long-term capital gains and qualified dividends. The tax rate will be 18.8% for those subject to the 3.8% surtax (i.e., those with modified adjusted gross income over $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
Permanent Alternative Minimum Tax Relief
The 2012 Taxpayer Relief 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 2012 Taxpayer Relief 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 January 1, 2012, the 2012 Taxpayer Relief 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 January 1, 2012, the AMT exemption amounts are indexed for inflation.
Also, prior to the 2012 Taxpayer Relief Act 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—would have been allowed in 2012 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 January 1, 2012, the 2012 Taxpayer Relief Act permanently allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits.
Personal Exemption Phaseout Limitations Reinstated
For tax years beginning January 1, 2013, the Personal Exemption Phaseout (“PEP”), which had previously been suspended, is reinstated with a starting adjusted gross income (“AGI”) threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 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.
Itemized Deduction Limitations Reinstated
For tax years beginning January 1, 2013, the “Pease” limitation on itemized deductions, which had previously been suspended, is reinstated with a starting threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 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 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.
Historical Individual Tax Extenders
- The 2012 Taxpayer Relief Act extends the following tax items through the end of 2013:
- Deduction for certain expenses of elementary and secondary school teachers;
- Exclusion for discharge of qualified principal residence indebtedness;
- Treatment of mortgage insurance premiums as qualified residence interest;
- Option to deduct State and local general sales taxes;
- The special rule for contributions of capital gain real property made for conservation purposes;
- The above-the-line deduction for qualified tuition and related expenses; and
- Tax-free distributions from individual retirement plans for charitable purposes are continued through 2013. Since 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 to be deemed as made on December 31, 2012.