New Federal Tax Legislation Summarized
On New Year’s Day, Congress completed its compromise to avoid the fiscal cliff. Here are the highlights of the legislation, the American Taxpayer Relief Act of 2012 (H.R. 8), which will impact your taxes:
The top stated tax rate will be increased from 35% to 39.6% for individual taxpayers with taxable incomes above $450,000 for joint filers and $400,000 for single filers. The thresholds for the top rate shall be indexed for inflation. We use the word “stated" as Congress has included in this legislation phase-outs of exemptions and itemized deductions (item 5 below) which, in effect, increase the marginal rate of taxation. In addition, previous legislation related to Obama-Care added additional taxes (see below).
The AMT patch has been “fixed" for the 2012 tax year, thus avoiding a delay in the processing of 2012 tax returns. It has also been fixed permanently so that patches will not be needed going forward. The “fix" has been made permanent by enacting legislation which indexes the AMT exemptions.
Capital Gains rates for long-term capital transactions and the rates on qualified dividend income will increase from 15% to at 20% effective 1/1/2013 for those with incomes above $450,000 (joint) or $400,000 (single). In reality, with additional changes already going into effect for Net Investment Income, the top federal tax rate on long-term capital gains will be 23.8% on the “rich" and continue at 15% for middle-class America.
The Estate Tax Exemption, which had been scheduled to fall from $5 million to $1 million will remain at $5 million for 2013 and will be adjusted for inflation going forward. However, the estate tax rate will increase from a maximum of 35% in 2012 to a maximum of 40% in subsequent years.
To raise additional revenue, Congress re-enacted provisions that phase-out one’s exemptions and certain itemized deductions. The phase outs, which will impact taxpayers with income over $300,000 (joint) and $250,000 (single) is, effectively, a rate increase of approximately 1% on taxable income. The thresholds shall be adjusted for inflation.
Among many other provisions, the following most significant provisions to our clients are now extended through 12/31/2013:
· The R&D tax credit;
· The 15-year accelerated recovery period for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements;
· $500,000 per year deduction for certain fixed assets under section 179 of the Internal Revenue Code; and
· The shorter 5-year period (as opposed to 10 years) for the application of the S Corporation Built-In gains tax pursuant to Internal Revenue Code §1374(d)(7).
The 50% bonus depreciation benefit of IRC §168(k) is extended one year through the end of 2013.
The 2% payroll tax cut on Social Security taxes the past 2 years (2011 and 2012) has NOT been renewed. Thus, the employee share of Social Security taxes will increase from 4.2% to 6.2% (making the total employee share of Social Security and Medicare taxes increasing from 5.65% to 7.65%).
It should be noted that the provisions above are those that have the greatest impact upon our clients. The bill passed by the Senate (and ultimately by the House, H.R. 8) was 157 pages. There are many other provisions, such as the extension of energy-related tax incentives, which have been incorporated into the legislation.
Not related to tax legislation, H.R. 8 includes several other important provisions:
A. Unemployment benefits for the long-term unemployed have been extended for another year through the end of 2013.
B. The anticipated cut in Medicare Reimbursements to physician payments, along with other health provisions, has been delayed through the end of 2013.
C. A one-year extension of certain agricultural programs.
D. Elimination of Congress’ cost of living adjustment for 2013, thereby freezing executive compensation.
It is important for you to know that due to previous legislation, the following tax changes are taking place for 2013:
There will be a new 0.9% Health Insurance Tax on Earned Income in excess of $250,000 for Joint Filers, $200,000 for Single Filers. This is withheld from the employee’s pay and NOT matched by employers.
There will be a 3.8% Medicare Contribution Tax on net investment income, including non-business capital gains, to the extent net investment income places one’s total income over $250,000 for Joint Filers and $200,000 for Single Filers. Note that this tax also will impact trusts and estates. Essentially, the target of the tax is to place an additional tax on unearned income. Such unearned income will include non-business capital gains, rents, royalties and annuities in addition to typical sources of investment income from gains in publicly-traded stocks, interest income, and dividend income. The definition of Net Investment Income under the IRS proposed regulations is complex, taking over 100 pages thus far. Passive activities will fall within the definition of Net Investment Income. Taxable gains from the sale of one’s personal residence (that is the gains in excess of the normal exclusions) is also considered part of the Net Investment Income computation.
The threshold for deduction medical expenses for those under the age of 65 will be increased from 7.5% of Adjusted Gross Income (“AGI") to 10% of AGI. The threshold for those who have reached the age of 65 or have a spouse that has reached the age of 65 will remain at 7.5%. So, if you are age 60 and your spouse is 65 by the end 2013, the threshold for the two of you filing jointly will remain at 7.5% and not increase to 10%. The threshold for medical expenses in determining the Alternative Minimum Tax (“AMT") will remain at 10% for all taxpayers as it did prior to 2013.
The amount one may set aside for medical expenses in flexible spending accounts is now capped at $2,500 per year commencing in 2013. The $2,500 cap will be adjusted for inflation each year subsequent to 2013.