Caught while falling off the fiscal Cliff – Congress passes a solution

After extensive debate, the Senate and House of Representatives passed the “American Taxpayer Relief Act” on January 1, 2013, which was signed into law by the President on January 2.
The new legislation contains provisions impacting both commercial and individual taxpayers.
Business Tax Provisions:

  • The Research and Development Tax Credit has been liberalized and extended through 2013.
  • 50% bonus depreciation on tangible personal property (along with certain limitations for automobiles) has been extended through 2013.
  • The rule treating qualified leasehold improvement property and qualified restaurant property as depreciable over a 15 year life has been reinstated retroactively to 2012 and extended through 2013. These properties are also eligible for 50% bonus depreciation.
  • The threshold to expense tangible personal property used in a trade or business under “IRC 179” has retroactively been increased to $500,000 for 2012 and 2013.
  • The Work Opportunity Tax Credit has been extended for both veterans and non-veterans hired for employment before 2014.
  • The 100% exclusion on the sale of certain small business stock has been extended through 2013.
  • The New Markets Tax Credit has been reinstated and extended through 2013.

Individual Tax Provisions:

  • Starting in 2013, a new top income tax rate of 39.6% will apply to taxable income in excess of $400,000 (single filers) and $450,000 (joint filers).
  • Tax rates on dividends and long term capital gain income remain at 0/%15% for all taxpayers below the $400,000 (single) and $450,000 (joint) income levels.  For those individuals with taxable income above these thresholds, the rate increases to 20%. This rate applies to all such income, not just the amount in excess of these income levels.
  • The higher exemption amounts for alternative minimum tax (AMT)-the so-called “AMT patch”-are made permanent, retroactive to 2012, significantly reducing the number of taxpayers subject to the AMT.
  • The limitations and phase-outs on itemized deductions and personal exemptions, respectively, remain in effect, starting in 2013.  It will apply to individuals whose Adjusted Gross Income exceeds $250,000 (single filers) or $300,000 (joint filers).
  • The $5 million exemption for estate, gift, and generation-skipping transfer (GST) tax purposes remains in place (subject to inflation-related increases).  Starting in 2013, the top tax rate applied to taxable estates and related transfers increases from 35% to 40%.
  • A number of individual tax credits such as the college tuition credit and the child tax credit were extended.
  • Taxpayers receiving required minimum distributions from IRA’s may once again designate that they be transferred directly to a charity.  This change applies to 2012 and 2013, with additional guidance to come regarding the retroactive treatment of 2012 distributions that had been received in cash, absent this provision.

Other Important Considerations:

  • The 2% reduction in the employee share of the Social Security tax was not extended.  As of January 1, 2013, this tax reverts to its pre-2011 level of 6.2% for both employees and self-employed individuals.
  • The new tax rates on high income individuals are applied in addition to 3.8% Medicare “surtax” on investment income and the 0.9% Medicare payroll tax increase on earned income signed into law as part of the Patient Protection and Affordable Care Act of 2010. These additional taxes are applicable to individuals with Modified Adjusted Gross Income in excess of $200,000 (single filers) or $250,000 (joint filers).
  • The new rules make the process of determining one’s marginal tax rate extremely difficult.  For example, a single individual with taxable income of $399,000 would find that receiving a $2,000 bonus in December not only subjects $1,000 of the income to the new top tax rate, but also (a) increases the tax rate on all dividend and long term capital gain income from 15% to 20%, (b) reduces the benefit of itemized deductions and personal exemptions, and (c) is subject to additional Medicare taxes.

The bill includes a number of nontax provisions, including an extension of long-term unemployment benefits and a delay in a 27% reduction of payments to Medicare doctors that was scheduled to go into effect. The implementation of mandated spending cuts that were to take effect in the absence of a bill is also delayed by two months.  Over the coming weeks, there will be further debate concerning both areas to cut and the possible sources of additional revenue generation.
We will continue monitor this legislation as additional specifics become available.

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