Calculating the tax effects of a crisis averted: The American Taxpayer Relief Act of 2012
History will show that 2013 began not with a bang, but with a sigh — of relief. That was the reaction of many Americans when Congress pulled up just short of the “fiscal cliff” and passed the American Taxpayer Relief Act of 2012 (ATRA). The law should send taxpayers reaching for their calculators to ascertain the tax effects of a crisis averted.
Tax rates hold, mostly
Had ATRA not been passed, individual tax rates across all income levels would have increased considerably. Fortunately for most, the new law holds ordinary-income tax rates for 2013 and beyond steady at 10%, 15%, 25%, 28%, 33% and 35%. The steeper 39.6% rate, however, will permanently return. It will be levied on taxable income exceeding $400,000 for singles, $425,000 for heads of households and $450,000 for married couples filing jointly.
Limits on some itemized deductions and on personal exemptions will also permanently return beginning with the 2013 tax year. These limits will apply to those with taxable incomes of more than $250,000 (singles), $275,000 (heads of households) and $300,000 (joint filers).
For most income levels, long-term capital gains rates will permanently stick to 0% and 15%. Higher-income taxpayers will, however, face the permanent return of the 20% rate. The taxable income thresholds for the 20% rate are the same as for the 39.6% ordinary-income rate.
Qualified dividends will permanently continue to qualify for long-term capital gains treatment. But taxpayers who face the higher 20% rate on long-term capital gains generally will also face it on qualified dividends. This is still much lower than the ordinary-income rate that would have applied without ATRA.
AMT not as potent
Higher regular income tax rates weren’t the only chilling aspect of tumbling off the fiscal cliff. So was the likelihood that many more people would be subject to the alternative minimum tax (AMT).
The AMT is a separate tax system designed to ensure that wealthy taxpayers with “excessive” deductions would pay some income tax. Basically, if your AMT liability exceeds your regular income tax liability, you must pay the AMT.
To calculate AMT income, your taxable income is modified by various adjustments and preferences (which are more restrictive than the regular tax system’s) and then reduced by an exemption that phases out at higher income levels.
Those exemption amounts are key because, as they diminish, more taxpayers become subject to the AMT. Before ATRA, the 2012 AMT exemptions were $33,750 for singles and heads of households and $45,000 for joint filers — significant drops from the 2011 exemptions.
Fortunately, the act permanently — and retroactively to Jan. 1, 2012 — extends higher exemption amounts. For 2012, the exemptions are $50,600 for singles and heads of households and $78,750 for joint filers. Beginning with the 2013 tax year, these amounts will be indexed for inflation.
Estate plans need review
Those concerned about estate planning are probably getting used to change, because there has been much uncertainty in this area for more than a decade. ATRA does bring a tax increase, but not the drastic sort found at the bottom of the fiscal cliff.
Gift, estate and generation-skipping transfer (GST) taxes will all moderately increase. For 2013 and future years, the top rate will rise five percentage points to 40% — still much less than the 55% that would have taken effect absent ATRA.
On the bright side, the gift, estate and GST tax exemptions will permanently remain high, rather than dropping to the $1 million level previously scheduled to return for 2013. The exemptions also will be adjusted annually for inflation. So the 2013 exemption will be a bit more than the 2012 amount of $5.12 million.
Specifics to discuss
Remember those calculators we mentioned in our opening? We were being figurative. The best course of action in light of ATRA’s passage is to contact your tax advisor and discuss the specifics of how its provisions affect you.
How are businesses affected?
The changes wrought by the American Taxpayer Relief Act of 2012 (ATRA) apply mainly to individual tax planning. But business owners have some things of which to take note as well.
For starters, if your company is structured as an S corporation, partnership or limited liability company, you’ll need to check into whether and how the tax rate changes for individuals will affect you. Because income from your business “flows through” to your personal tax return, it could be subject to the higher 39.6% tax rate. (See “Tax rates hold, mostly” in the main article.)
On a more positive note, ATRA extends through 2013 (and in some cases also retroactively to Jan. 1, 2012) a variety of tax breaks to which your company has perhaps grown accustomed. These include valuable depreciation-related items such as 50% bonus depreciation; higher levels of Section 179 expensing; and accelerated depreciation for qualified leasehold, retail and restaurant improvements.
If you hired in 2012 or plan on hiring this year, be aware the Work Opportunity credit has been extended. And, should innovation be more your game, you’ll appreciate that the research and development credit has been extended as well.