“…many families and individuals below the 39.6% rate bracket will see their effective tax rates increase beyond 35%.”
The uncertainty concerning the year-end “Fiscal Cliff” has now been settled, and many Americans are seeking to understand how the American Taxpayer Relief Act of 2012 (the “Act”) will affect their personal taxes as well as the taxation of their businesses in 2013 and beyond. The following bulletin summarizes the “highlights” of the Act and certain other tax changes for 2013. Many taxpayers may be surprised to learn that the Act has implications well beyond increasing taxes for Americans making in excess of $400,000.
I. Provisions Affecting Individuals
Most discussion concerning the Act has focused on tax rates applicable to United States individual taxpayers for taxable years beginning after December 31, 2012. But as the provisions listed below indicate, the Act affects many other aspects of individual federal income taxation:
- The Act permanently extends the income tax rates applicable to most individuals during 2012 but sets a new marginal tax rate of 39.6% for individuals with taxable income in excess of $450,000 if married filing a joint return or $400,000 if single.
- The Act does not extend the 2% payroll tax reduction for all United States wage earners and self-employed individuals. Notably, this is in addition to the previously passed 0.9% payroll tax increase that applies in 2013 to individuals’ wages in excess of $250,000 if married filing a joint return or $200,000 if single.
- The Act leaves the qualified dividends and long-term capital gains rate at 15% (or below) for all individuals except those with incomes that exceed the applicable 39.6% rate thresholds (described above). For such taxpayers, the new rate is 20%. Note however, as under prior law, dividends from certain foreign corporations or with respect to which various holding period requirements cannot be met will continue to be taxed as ordinary income at a maximum rate of 39.6%. Further, under previously enacted legislation, both qualified and unqualified dividends generally are subject to an additional 3.8% tax for individuals with adjusted gross incomes in excess of $250,000 if married filing a joint return or $200,000 if single, effective January 1, 2013.
- The Act both permanently sets and indexes for inflation the individual alternative minimum tax (the “AMT”) exemption amounts at $78,750 if married filing a joint return or $50,600 if single. This adjustment is intended to protect most middle income individual taxpayers from the AMT, now and in the future, without the need for Congress to annually enact a one or two-year “patch.”
- The Act reduces the personal exemption amount for individuals with adjusted gross incomes in excess of $300,000 if married or $250,000 if single by 2% for each $2,500 by which their adjusted gross income exceeds the applicable threshold amount. The Act indexes the initial $300,000 and $250,000 threshold amounts for inflation. Together with the phase-out of most itemized deductions for this set of taxpayers, many families and individuals below the 39.6% rate bracket will see their effective tax rates increase beyond 35%.
- The Act also requires individuals with adjusted gross incomes in excess of $300,000 if married filing a joint return or $250,000 if single to reduce their itemized deductions by 3% of the amount by which their adjusted gross income exceeds the applicable threshold amount, but in no event will this reduction exceed 80% of the total of such deductions.
II. Provisions Affecting Businesses
In addition to the provisions affecting individual tax rates described above, the following business-related provisions are also contained within the Act:
- The Act extends through the end of 2013 “bonus depreciation,” which generally permits a business to deduct 50% of the cost of qualified property placed in service before January 1, 2014.
- The Act increases the maximum amount of business expensing under Section 179 to $500,000 through the end of 2013. If, however, the amount of Section 179 property placed in service during 2013 exceeds $2,000,000, the maximum amount is reduced dollar-for-dollar by the amount of costs in excess of $2,000,000.
- The Act extends the fifteen-year straight-line depreciation method for qualifying leasehold, retail, and restaurant improvement property placed in service by January 1, 2014. Absent the Act, such property generally would be depreciable over 39 years.
- The Act extends through the end of 2013 the ability to exclude all of the gain from the sale of section 1202 qualified small business stock.
- The Act limits the S corporation built-in gains tax recognition period to five years for S corporation tax years beginning in both 2012 and 2013. This period generally represents the amount of time that must lapse before an S corporation can dispose of assets with unrecognized built-in gain at the time of conversion from a C corporation to an S corporation without incurring double taxation on such gain. Note, absent further Congressional action, an S corporation will revert to the ten-year recognition period in 2014. Thus, an S corporation that converted within the last nine years may want to consider whether or not assets should be sold during 2013.
- The Act extends various business-related tax credits, including the Research Tax Credit, the New Markets Tax Credit, and the Work Opportunity Tax Credit.
- The Act extends various “green” tax subsidies.
Attorneys in Taft’s Tax group are available to discuss the American Taxpayer Relief Act of 2012. We encourage you to contact us with any questions.