In a move to avoid the fiscal cliff, the U.S. Senate, early on the morning of January 1, 2013, overwhelmingly passed a compromise bill, H.R. 8, the American Taxpayer Relief Act of 2012 (“ATRA“), to extend and replace numerous provisions of the Internal Revenue Code, among other changes. Following the Senate vote, later in the evening on January 1, 2013, the U.S. House passed the Senate bill without any amendments. The bill was signed into law by President Obama on January 2, 2013.
As a result of ATRA, several laws that included sunset provisions have been made permanent, including the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA“), the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA“) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. In addition, ATRA provides for a permanent fix for the alternative minimum tax (“AMT“). Furthermore, numerous individual and business tax extenders are reauthorized; numerous energy tax provisions are extended; the unemployment compensation program has been extended; a “doc fix” for payments to doctors who accept Medicare patients has been implemented; and certain agricultural programs preventing a significant increase in milk prices have been extended. ATRA also includes budgetary provisions, including additional budgetary effects that postpone sequester until March 1, 2013.
The following are highlights of the major tax relief provisions included in ATRA.
Income Tax Rates
Under ATRA, with respect to the income tax rate brackets for individuals, the lowest income tax bracket of 10% will remain. In addition, the four income tax rate brackets of 25%, 28%, 33% and 35% will remain. However, a new top tax rate of 39.6% will apply to those married filing jointly with taxable income in excess of $450,000 as well as to unmarried individuals with taxable income in excess of $400,000. These threshold amounts will be adjusted for inflation.
In addition, those with a modified adjusted gross income (“MAGI“) of $250,000 if married filing jointly, or unmarried individuals with a MAGI of $200,000, may also be subject to a Net Investment Income tax of 3.8% on unearned income in excess of their MAGI threshold as a result of the implementation of the Affordable Care Act (“ACA“).
Maximum Capital Gains Tax Rate
As a result of ATRA, long-term capital gains will be taxed at 0% for taxpayers in the 10% and 15% brackets, and 15% for those taxpayers taxed in the 25%, 28%, 33% and 35% tax brackets. For those taxpayers that fall into the 39.6% tax bracket, the top long-term capital gain tax rate will be 20%.
ATRA provides that qualified dividends will continue to be taxed at the same rates as long-term capital gains. That is, 0% for taxpayers in the 10% and 15% brackets and 15% for those taxpayers taxed in the 25%, 28%, 33% and 35% tax brackets. For those taxpayers that fall into the 39.6% tax bracket, the top tax rate on qualified dividends will be 20%.
The changes resulting from the enactment of ATRA to the individual income tax brackets and rates on capital gains and qualified dividends will be permanent.
No Extension of the Payroll Tax Holiday
Because the Payroll Tax Holiday has expired with no evidence of a desire to extend by the White House or Congress, employees will pay an additional 2%, or 6.2% from 4.2%, for their share of the Social Security (OASDI) tax, resulting in the total employee share of payroll taxes being 7.65%. For 2013, the Social Security (OASDI) tax wage base has increased to $113,700 from $110,100 in 2012.
In addition, certain high-income earners (those with covered wages or compensation exceeding threshold amounts of $250,000 if married filing jointly and $200,000 for unmarried individuals) will also see an additional increase of 0.9% to 8.55% for their share of payroll taxes as a result of an additional Medicare Tax arising from the implementation of the ACA. This 0.9% additional Medicare tax applies to the earnings that exceed the threshold amounts. With respect to self-employed individuals, the 0.9% additional Medicare tax will apply to self-employment income in excess of the threshold amounts.
Last month, we addressed in more detail the additional Medicare tax as well as the Net Investment Income Tax brought about by the ACA. See End-of-Year Tax Planning—Avoiding a Free-Fall Off the Fiscal Cliff; How to Rappel to a Softer Landing.
Permanent Fix for the Alternative Minimum Tax
ATRA makes permanent a retroactive increase in the Alternative Minimum Tax (“AMT“) exemption amounts beginning for 2012. The 2012 exemption amounts are $78,750 for those married filing jointly, $50,600 for unmarried individuals and $39,375 for married filing separately. For years after 2012, the exemption amounts will be adjusted for inflation.
The Estate Tax and Portability of the Deceased Spousal Unused Exclusion
As a result of ATRA, the maximum estate tax rate permanently increases from 35% to 40% for decedents dying after December 31, 2012. However, it also maintains the inflation-adjusted $5 million exemption amount ($5,120,000 for 2012). In addition, portability of the deceased spousal unused exclusion also becomes permanent.
Personal Exemption Phaseout / Itemized Deduction Limitation
Higher-income taxpayers are now subject to the return of the Personal Exemption Phaseout (“PEP”) and a limitation on itemized deductions.
Personal Exemption Phaseout
The revival of the PEP rules reduces or eliminates the deduction for personal exemptions for higher-income taxpayers. The phaseout operates by reducing the personal exemption by 2% for every $2,500 over a threshold amount of adjusted gross income (“AGI“). Under ATRA, for 2013 the threshold amount is $300,000 AGI for those married filing jointly, $275,000 AGI for heads of household and $250,000 AGI for unmarried individuals. The threshold amounts will be adjusted each year after 2013 for inflation.
Limitation on Itemized Deductions
The return of the limitation on itemized deductions (known as the Pease limitation) reduces itemized deductions by 3% of the taxpayer’s AGI in excess of the threshold inflation-adjusted amount, but not by more than 80% of the itemized deductions otherwise allowable for the tax year. Under ATRA, for 2013 the threshold amount is $300,000 AGI for those married filing jointly, $275,000 AGI for heads of household and $250,000 AGI for unmarried individuals. The threshold amounts will be adjusted each year after 2013 for inflation.