In late 2012, Congress agreed to resolve the so-called fiscal cliff with, among other things, various tax changes that were formally adopted in early 2013. These changes and other key developments in the fourth quarter of 2012 are summarized below. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
Tax changes under fiscal cliff legislation mostly positive. The American Taxpayer Relief Act of 2012 (the new law or the Act) was signed into law by the President on Jan. 2, 2013. It is a sweeping tax package that includes, among many other items, a permanent extension of the Bush-era tax cuts for most taxpayers, permanent relief from the alternative minimum tax (AMT) for individual taxpayers, and a host of retroactively resuscitated and extended tax breaks for individuals and businesses. The Act also increases income taxes and limits deductions and exemptions for some high-income individuals. In addition, it provides permanent estate, gift and generation-skipping transfer tax relief, although with a slightly higher rate than applied for 2012. More specifically, the Act has made these tax law changes:
Tax rates. For tax years beginning after 2012, the 10%, 15%, 25%, 28%, 33% and 35% tax brackets from the Bush tax cuts remain in place and are made permanent. This means that, for most Americans, the tax rates stay the same. However, there is a new 39.6% rate, which begins at the following taxable income thresholds: $400,000 (single), $425,000 (head of household), $450,000 (joint filers and qualifying widow(er)s), and $225,000 (married filing separately). These dollar amounts will be inflation-adjusted for tax years after 2013.
Estate tax. The new law 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, it permanently increases the top estate and gift tax rate, and the GST rate, from 35% to 40%. It 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.
Capital gains and qualified dividend rates. The new law retains the 0% tax rate on long-term capital gains and qualified dividends, modifies the 15% rate, and establishes a new 20% rate for tax years beginning in 2013.
Personal exemption phaseout. For tax years beginning in 2013, personal exemptions are phased out (i.e., reduced) for taxpayers whose adjusted gross income is over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). These dollar amounts are inflation-adjusted for tax years after 2013.
Itemized deduction limitation. For tax years beginning in 2013, many itemized deductions are limited for taxpayers whose adjusted gross income is over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers).
AMT relief. The new law provides permanent alternative minimum tax (AMT) relief. 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 new law 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. For 2013, the AMT exemption amounts are $51,900 for unmarried taxpayers, $80,800 for joint filers, and $40,400 for married persons filing separately. The new law also permanently allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits.
Tax credits for low to middle income taxpayers and wage earners. The new law extends for five years the following items that were originally enacted as part of the 2009 stimulus package and were slated to expire at the end of 2012: (1) the expanded American Opportunity tax credit, which provides up to $2,500 in refundable tax credits for undergraduate college education; (2) favorable rules for determining the refundable portion of the child tax credit; and (3) various earned income tax credit changes.
Cost recovery. The new law extends the period during which (1) higher amounts may be expensed (i.e., currently deducted in full rather than depreciated over several years) and certain real property is eligible for expensing. It 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.
Tax break extenders. Congress has historically extended many popular tax provisions every few years as they are about to expire or even after they have expired. The new law has extended many of these traditional extenders for two years, retroactively to 2012 and through the end of 2013. Among many others, the extended provisions include the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes, the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers, and the research credit.
Pension provision. The new law includes a pension provision that removes many of the limitations on making a qualified rollover from a qualified plan to a designated Roth account in an “in-plan Roth rollover.” This change makes it easier than ever to realize the benefits of a popular retirement plan option, a Roth account. Making a rollover contribution to a Roth account doesn’t come without a price. In exchange for tax-free distributions from the account down the road, an immediate tax is triggered on the amount rolled over from a qualified plan.
New simplified option for claiming home office deduction. The IRS has provided an optional safe harbor method that individuals can use to determine the amount of their deductible home office expenses, effective for tax years beginning on or after Jan. 1, 2013. The safe harbor-$5 × square feet of qualified use (up to 300 square feet)-provides an alternative to the calculation, allocation, and substantiation of actual expenses that would otherwise be required. Using the safe harbor will substantially reduce the record keeping burden for an individual who qualifies for and takes a home office deduction. Also, the audit risk for those using the safe harbor may be lower.
Guidance fleshes out new Medicare tax on higher earners. For tax years beginning after 2012, there’s an additional 0.9% Medicare (hospital insurance, or HI) tax on taxpayers (other than corporations, estates, or trusts) receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately). Late last year, the IRS issued long-awaited guidance for employers and individuals on this new additional 0.9% Medicare tax. The guidance was issued in the form of detailed regulations and Q&As (questions and answers). It may cause complications for employers, employees and self-employed persons. The guidance explains when the additional tax triggers withholding, the types of payments subject to withholding, the impact on estimated taxes, and how the tax applies to taxpayers who have both income from employment and self-employment, among other items. A taxpayer who anticipates owing additional Medicare tax but won’t satisfy the liability through withholding may need to make estimated tax payments.
Government disagrees with fixed dollar gifts of business interests. Some donors of gifts have attempted to make transfers that call for the transaction to be recharacterized or for the donee to return a portion of the gift if the IRS determines that the gift had a higher value than the reported value. Many courts have disregarded such savings clauses, as they are called. More recently, however, courts have allowed fixed dollar gifts of interests in partnerships and limited liability companies (LLCs). For example, in one recent case, the Tax Court held that individuals transferred gifts of a specified dollar value of membership units in an LLC to their children and grandchildren. It rejected the IRS’s contentions that the gifts were of fixed percentage interests in the LLC and void as against public policy. The Court did so even though the interests received by the donees, when expressed as a percentage of units in the LLC, were lowered as a result of an IRS audit increasing the value of a unit in the LLC. The IRS has announced that it disagrees with this decision and thus will continue to challenge fixed dollar gifts or defined value gifts, as they are otherwise known.
Bankrupt companies may eliminate lump-sum pension option. Fewer companies maintain traditional pension plans for employees these days. Many plans that are still in existence are underfunded, and sponsors of some plans are bankrupt. With respect to the latter, the IRS has issued regulations that allows bankrupt companies to eliminate a lump-sum option under their pension plans (or other optional form of benefit providing for accelerated payments) if four conditions are satisfied. Employees of bankrupt companies with pension plans could be affected by this change.
Standard mileage rates up. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 56.5¢ per each business mile traveled after 2012. That’s 1¢ more than the 55.5¢ allowance for business mileage during 2012. Further, the 2013 rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 24¢ per mile, 1¢ more per mile than the 23¢ for 2012.
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