We Avoided the Cliff. Now What?

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The American Taxpayer Relief Act enacted January 2, 2013 avoided many of the tax increases that were scheduled to take effect on January 1, 2013.  The Act raises income tax rates for high-income individuals, increases the tax rate on most dividends and long-term capital gains and also increases the estate and gift tax rates.

Below is an explanation of some of the more significant provisions of the Act:

Income Tax Rates:  For tax year 2103 and thereafter, the income tax rates for most individuals will remain at the 2012 levels of 10, 15, 25, 28, 33 and 35 percent.  (These rates had been scheduled to increase to 15, 28, 31, 36 and 39.6 percent).  However, the Act introduces a 39.6% rate for certain high-income taxpayers.  This 39.6% rate only applies to income in excess of an “applicable threshold,” which is $450,000 for joint filers and surviving spouses, $425,000 for heads of household, $400,000 for single filers and $225,000 for married taxpayers filing separately.  The 39.6% bracket for taxable income also applies to trusts and estates with over $11,950.00.  There is no 35% tax bracket for estates and trusts.  These dollar amounts will be inflation-adjusted. 

Capital Gains/Dividends:  Long-term capital gains and “qualified dividends” will, for most taxpayers, continue to be taxed at a maximum rate of 15 percent, with those persons in the 10 and 15 percent income tax brackets continuing to be exempt from such tax.  Qualified dividends are dividends paid by U.S. Corporations and dividends paid by “qualified foreign corporations,” which are foreign corporations located in aU.S. possession or in a country with which the United States has a comprehensive income tax treaty.  Those taxpayers who are subject to the 39.6% income tax rate will be subject to the increased 20% tax rate on such capital gains and dividends.

Estate and Gift Taxes:  The Act retains the 2012 estate and gift tax exemption of $5 million (indexed for inflation with 2011 as the base year), but increases the tax rate on transfers in excess of this amount from 35 to 40 percent.  For 2013, the inflation adjusted exemption amount is $5.25 million.  The Act also continues the portability feature of the estate tax law, which allows a surviving spouse to utilize his or her deceased spouse’s unused exemption amount, and makes permanent many other technical amendments to the estate and gift tax law that have been enacted over the past  12 years. 

Personal Exemption Phase out (PEP) limitations to Apply to “High Earners”:  The Act reinstates the Personal Exemption Phase out (PEP), which previously had been suspended, with a starting threshold of adjusted gross income above $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. 

Pease limitations to apply to “High-Earners”.  The Act also reinstates the “Pease” limitation on itemized deductions, which had previously been suspended, with a starting threshold of AGI above $300,000 for joint filers and surviving spouse, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately.  A taxpayers subject to the “Pease” limitation will have his/her itemized deductions reduced by 3 percent of the amount by which the taxpayer’s AGI exceeds the threshold amount, with the reduction not to exceed 80 percent of the otherwise allowable itemized deductions. 

Alternative Minimum Tax.  The Act provides permanent AMT relief by increasing the exemption amounts and indexing it for inflation going forward.   

Exclusion of Small Business Capital Gains.  Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years.  For stock acquired after December 31, 2011 and before January 1, 2014, the exclusion is 100 percent and the AMT preference item attributable for the sale is eliminated.  The Act extends for one year the 100 percent exclusion of the gain from the sale of qualifying small business stock through 2013. 

Subpart F Foreign Income Tax Rules.  There are several look-through rules applicable to controlled foreign corporations and the Act extends these look through rules.

Other Miscellaneous Deductions and Credits Extended.  The Act extends:

  • Provisions allowing teachers a deduction for $250 of classroom expenses, as well as the $100,000 charitable donation of IRA assets by account owners age 70.5 and older. 
  • A one year extension of current “bonus” depreciation rules, that allow businesses to deduct up to 50 percent of the cost of a wide variety of property and equipment, excluding real estate. 
  • Through 2013 the exclusion of certain income from the discharge of qualified principal residence indebtedness. 

Increase in Employee Paid Payroll Taxes.  The 2% payroll tax holiday that taxpayers have enjoyed for the past two tax years expired at the end of 2012. 

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