American Taxpayer Relief Act - The MOST IMPORTANT changes!

03 January 2013 / Uncategorized / Comments Off on American Taxpayer Relief Act - The MOST IMPORTANT changes!

American Taxpayer Relief Act - The MOST IMPORTANT changes!

President Barack Obama has signed into law a bill to avert the fiscal cliff, a day after the House and Senate approved the much-debated legislation.  This article outlines the major tax changes that appear in this bill.

Individual tax rates

All the individual marginal tax rates are retained (10%, 15%, 25%, 28%, 33%, and 35%).  A new top rate of 39.6% is imposed on taxable income over $400,000 for single filers and $450,000 for married taxpayers filing jointly.

Phaseout of itemized deductions and personal exemptions

The personal exemptions and itemized deductions phaseout is reinstated at a higher threshold of $250,000 for single taxpayers and $300,000 for married taxpayers filing jointly.

Capital gains and dividends

The zero rate is retained for taxpayers in the 10% and 15% brackets; the 15% rate is retained for taxpayers in the middle brackets and a 20% rate applies to capital gains and dividends for individuals above the top income tax bracket threshold.

Alternative minimum tax

The exemption amount for the AMT on individuals is permanently (finally!) indexed for inflation. For 2012, the exemption amounts are $50,600 for single taxpayers and $78,750 for married taxpayers filing jointly.

Estate and gift tax

The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012), but the top tax rate increases from 35% to 40% effective Jan. 1, 2013.

The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act.

Permanent extensions

Various temporary tax provisions enacted were made permanent. These include:

  • Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2));
  • The liberalized child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
  • The exclusion for employer-provided educational assistance (Sec. 127);
  • The enhanced rules for student loan deductions (Sec. 221);
  • The employer-provided child care credit (Sec. 45F);

Individual credits that had expired at the end of 2012

The American opportunity tax credit for qualified tuition and other expenses of higher education was extended through 2018. Other credits and items that were extended for the same five-year period include enhanced provisions of the child tax credit under Sec. 24(d) and the earned income tax credit under Sec. 32(b).

Individual provisions that had expired at the end of 2011

The act also extended through 2013 a number of temporary individual tax provisions, most of which expired at the end of 2011:

  • Deduction for certain expenses of elementary and secondary school teachers (Sec. 62);
  • Exclusion from gross income of discharge of qualified principal residence indebtedness (Sec. 108);
  • Mortgage insurance premiums treated as qualified residence interest (Sec. 163(h));
  • Deduction of state and local general sales taxes (Sec. 164(b));
  • Above-the-line deduction for qualified tuition and related expenses (Sec. 222); and
  • Tax-free distributions from individual retirement plans for charitable purposes (Sec. 408(d)). 

Business tax provisions that had expired at the end of 2011 and 2012

The act also extended many business tax credits and other provisions. Notably, it extended through 2013 and modified the Sec. 41 credit for increasing research and development activities, which expired at the end of 2011.  The credit is modified to allow partial inclusion in qualified research expenses and gross receipts those of an acquired trade or business or major portion of one.

The increased expensing amounts under Sec. 179 are extended through 2013. The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) was also extended for one year by the act. It now generally applies to property placed in service before Jan. 1, 2014.

Other common business provisions extended through 2013, and in some cases modified, are:

  • Indian employment tax credit (Sec. 45A);
  • New markets tax credit (Sec. 45D);
  • Employer wage credit for employees who are active duty members of the uniformed services (Sec. 45P);
  • Work opportunity tax credit (Sec. 51);
  • Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e));
  • Enhanced charitable deduction for contributions of food inventory (Sec. 170(e));
  • Temporary exclusion of 100% of gain on certain small business stock (Sec. 1202);
  • Basis adjustment to stock of S corporations making charitable contributions of property (Sec. 1367);
  • Reduction in S corporation recognition period for built-in gains tax (Sec. 1374(d));
  • Empowerment Zone tax incentives (Sec. 1391);

Energy tax provisions that had expired at the end of 2011 and 2012

The act also extends through 2013 a number of energy credits and provisions that expired at the end of 2011:

  • Credit for energy-efficient existing homes (Sec. 25C);
  • Credit for energy-efficient new homes (Sec. 45L);
  • Credit for energy-efficient appliances (Sec. 45M);

Other important tax changes that occurred as of 01/01/2013

In addition to the various provisions discussed above, some new taxes and important changes in the law also took effect this as of 01/01/2013.  The most important of these changes are discussed below.

Additional Medicare tax on high-income taxpayers. The employee portion of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $200,000 for single taxpayers and $250,000 for married taxpayers filing a joint return.

For self-employed taxpayers, the same additional Medicare tax applies self-employment income in excess of the threshold amount.

Medicare tax on investment income. Sec. 1411 now imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (MAGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins.

For single taxpayers the threshold amount is $200,000; for married individuals filing a joint return the threshold amount is $250,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.

Medical care itemized deduction threshold. The threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.

Flexible spending arrangement. Effective for cafeteria plan years beginning after Dec. 31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for any plan year is $2,500.

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