On New Year’s Day 2013, Congress passed a far-reaching new law intended to avert the so-called fiscal cliff. The American Taxpayer Relief Act, signed into law by President Obama on January 2, 2013, impacts every taxpayer.
The American Taxpayer Relief Act preserves and permanently extends the Bush-era income tax cuts except for single individuals with taxable income above $400,000; married couples filing joint returns with taxable income above $450,000; and head of households with taxable income above $425,000. Income above these thresholds will be taxed at a 39.6 percent rate, effective January 1, 2013. The $400,000/$450,000/$425,000 thresholds will be adjusted for inflation after 2013.
The new law, however, does not extend the payroll tax holiday. Effective January 1, 2013, the employee-share of Social Security increased from 4.2 percent to 6.2 percent (its rate before enactment of the payroll tax holiday). The net result is that all individuals who receive wages (and self-employed individuals) will see less take-home pay in 2013.
Effective January 1, 2013, the maximum tax rate on qualified capital gains and dividends rises from 15 to 20 percent for taxpayers whose incomes exceed the thresholds set for the 39.6 percent rate on ordinary income (the $400,000/ $450,000/$425,000 thresholds discussed above). The maximum tax rate for all other taxpayers remains at 15 percent; moreover, a zero-percent rate will continue to apply to qualified capital gains and dividends to the extent income falls below the top of the 15 percent bracket.
Alternative Minimum Tax
The American Taxpayer Relief Act permanently patches the AMT by increasing the exemption amounts and indexing them for inflation.
The American Taxpayer Relief Act makes a valuable change to the treatment of retirement savings and opens up an important planning opportunity. Generally, participants with 401(k) plans and similar plans have been allowed to roll over funds to designated Roth accounts in the same plan subject to certain qualifying events or age restrictions. The American Taxpayer Relief Act lifts most restrictions, and now allows participants in 401(k) plans with in-plan Roth conversion features to make transfers to a Roth account at anytime. Congress made this change because conversion is a taxable event and will raise revenue.
Federal transfer taxes (estate, gift and generation-skipping transfer (GST) taxes) seem to have been in a constant state of flux in recent years. The American Taxpayer Relief Act aims to provide some certainty. Effective January 1, 2013, the maximum estate, gift and GST tax rate is generally 40 percent, which reflects an increase from 35 percent for 2012. The exclusion amount for estate and gift taxes is unchanged for 2013 and subsequent years at $5 million (adjusted for inflation). The GST exemption amount for 2013 and beyond is also $5 million (adjusted for inflation). The new law also makes permanent portability and some enhancements made in previous tax laws.
Tax credits and deductions
Like the Bush-era tax cuts, many popular tax credits and deductions were scheduled to expire after 2012 (in some cases, they expired after 2011). The American Taxpayer Relief Act makes some of these incentives permanent and extends others. One of the most widely used tax credits, the $1,000 child tax credit, was made permanent.
Phase-Out Rules Are Back
Prior to 2010, higher income taxpayers’ itemized deductions and personal exemption write-offs were subject to phase-out rules. The phase-out rules were deactivated for tax years 2010 through 2012. Unfortunately, the American Taxpayer Relief Act reactivates the phase-out rules on a permanent basis.
Personal and Dependent Exemption Deductions: Your personal and dependent exemption write-offs can be reduced or even eliminated.
Itemized Deductions: You can potentially lose up to 80 percent of your write-offs for mortgage interest, state and local income and property taxes, and charitable contributions if your adjusted gross income (AGI) exceeds the applicable threshold. Specifically, the total amount of your affected itemized deductions is reduced by 3 percent of the amount by which your AGI exceeds the threshold. However, the reduction cannot exceed 80 percent of the total affected deductions you started off with.
For both personal/ dependent exemptions and itemized deductions, the AGI thresholds are $250,000 for singles, $300,000 for married joint-filing couples, $275,000 for heads of households, and $150,000 for married individuals filing separately.
Other popular tax credits and deductions for individuals made permanent or extended by the new law include:
Enhanced adoption credit/exclusion (permanent)
Enhanced child and dependent care credit (permanent)
Enhanced student loan interest deduction (permanent)
American Opportunity Tax Credit (through 2017)
Higher education tuition deduction (through 2013)
IRA distributions to charitable organizations (through 2013)
Transit benefits parity (through 2013)
Cancellation of indebtedness on principal residence (through 2013)
Code Sec. 25C residential energy efficient property credit (through 2013)
Teachers’ classroom expense deduction (through 2013)
Bonus depreciation is one of the most important tax benefits available to businesses, large or small. In recent years, bonus depreciation has reached 100 percent, which gave taxpayers the opportunity to write off 100 percent of qualifying asset purchases immediately. For 2012, bonus depreciation remained available but was reduced to 50 percent. The American Taxpayer Relief Act extends 50 percent bonus depreciation through 2013 (through 2014 in the case of certain period production property and transportation property).
Bonus depreciation, unlike Code Sec. 179 expensing (discussed below), is not capped at a dollar threshold. However, only new property qualifies for bonus depreciation. Code Sec. 179 expensing, in contrast, can be claimed for both new and used property and qualifying property may be expensed at 100 percent.
Code Sec. 179 Expensing
In recent years, Congress has repeatedly increased dollar and investment limits under Code Sec. 179 to encourage spending by businesses. For tax years beginning in 2010 and 2011, the Code Sec. 179 dollar investment limits were $500,000 and $2 million, respectively. The American Taxpayer Relief Act boosts the dollar and investment limits for 2012 and 2013 to their 2011 amounts ($500,000 and $2 million) and adjusts those amounts for inflation. Keep in mind that the increase is temporary. The Code Sec. 179 dollar and investment limits are scheduled to decrease to $25,000 and $200,000 respectively after 2013 unless changed by Congress. The new law also provides that off-the-shelf computer software qualifies as eligible property for Code Sec. 179 expensing. The software must be placed in service in a tax year beginning before 2014. Additionally, the American Taxpayer Relief Act allows taxpayers to treat up to $250,000 of qualified leasehold and retail improvement property as well as qualified restaurant property as eligible for Code Sec. 179 expensing.
Leasehold, Retail and Restaurant property
The American Taxpayer Relief Act extends for 2012 and 2013 the special treatment of qualified leasehold and retail improvement property and qualified restaurant property as eligible for a 15-year recovery period. Otherwise, this property generally is depreciated over a 39-year recovery period. To take advantage of this enhanced expensing, the qualified property must be placed in service before January 1, 2014.
Other provisions affected by the new law include
Code Sec. 41 research tax credit
Work opportunities tax credit (WOTC)
Employer wage credit for activated military reservists
Reduced recognition period for S corporation built-in gains
Indian employment credit and accelerated depreciation for business property on Indian reservations
Code Sec. 45 production tax credit for renewable energy
Credits for biodiesel and ethanol
Incentives for manufacturers of energy-efficient new homes and appliances
Railroad track maintenance credit
Mine rescue team training credit
Unlike many of the individual taxpayer incentives in the American Taxpayer Relief Act, many business tax benefits are not made permanent. As a result, planning to maximize tax savings under these extended incentives takes on new urgency.
Please contact our office and we can discuss how the American Taxpayer Relief Act can help maximize your tax savings.