2013 Tax Rates - Another Kick of the Can

Chief Executive Boards International members have anxiously awaited resolution of the "Fiscal Cliff".  As some of us expected, Congress has kicked the can down the road another couple of months, slightly tinkering with a cumbersome and flawed tax code.   So, what is the result? 

I saw an email newsletter from Cincinnati-based CPAs Flynn and Company that's the most succinct article I've seen, particularly relative to small business.  Here's the article in its entirety:  

American Taxpayer Relief Act of 2012

On 1/2/13, President Obama signed the new legislation into effect which helped taxpayers by extending tax cuts that were set to expire, thereby preventing the fiscal cliff from occurring. The following is a summary of the important provisions of the new law.

INDIVIDUAL INCOME TAX PROVISIONS
Individual Income Tax Rates

• The American Taxpayer Relief Act of 2012 makes permanent for 2013 and beyond the lower Bush-era income tax rates for all, except for taxpayers with taxable income above $400,000 ($450,000 for married taxpayers, $425,000 for heads of households). Income above these levels will be taxed at a 39.6 % rate.

• The American Taxpayer Relief Act raises the top rate for capital gains and dividends to 20 percent, up from the Bush-era maximum 15 percent rate. That top rate will apply to the extent that a taxpayer's income exceeds the thresholds set for the 39.6 percent rate ($400,000 for single filers; $450,000 for joint filers and $425,000 for heads of households).

• All other taxpayers will continue to enjoy a capital gains and dividends tax at a maximum rate of 15 percent. A zero percent rate will also continue to apply to capital gains and dividends to the extent income falls below the top of the 15 percent income tax bracket—projected for 2013 to be $72,500 for joint filers and $36,250 for singles). Qualified dividends for all taxpayers continue to be taxed at capital gains rates, rather than ordinary income tax rates as prior to 2003.

• Installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later is now taxed at the 20 percent rate for higher-income taxpayers.

3.8% Tax on Net Investment Income

• Starting in 2013, under the Patient Protection and Affordable Care Act (PPACA), higher income taxpayers must also start paying a 3.8 percent additional tax on Net Investment Income (NII) to the extent certain threshold amounts of income are exceeded ($200,000 for single filers, $250,000 for joint returns and surviving spouses, $125,000 for married taxpayers filing separately). Those threshold amounts stand, despite higher thresholds now set for the 20 percent capital gain rate that previously had been proposed by President Obama to start at the same levels. The NII surtax thresholds are not affected by the American Taxpayer Relief Act. Starting in 2013, therefore, taxpayers within the NII surtax range must pay the additional 3.8 percent on capital gain, whether long-term or short-term. The effective top rate for net capital gains for many "higher-income" taxpayers thus becomes 23.8 percent for long term gain and 43.4 percent for short-term capital gains starting in 2013.

Alternative Minimum Tax

• The American Taxpayer Relief Act "patches" the AMT for 2012 and subsequent years by increasing the exemption amounts and allowing nonrefundable personal credits to the full amount of the individuals regular tax and AMT. Additionally, the American Taxpayer Relief Act provides for an annual inflation adjustment to the exemption amounts for years beginning after 2012.

New Limitations

• The American Taxpayer Relief Act officially revives the "Pease" limitation on itemized deductions, which was eliminated by EGTRRA as extended by the 2010 Tax Relief Act. However, higher "applicable threshold" levels apply under the new law:
  o  $300,000 for married couples and surviving spouses;
  o  $275,000 for heads of households;
  o  $250,000 for unmarried taxpayers; and
  o  $150,000 for married taxpayers filing separately.

The Pease limitation reduces the total amount of a higher-income taxpayer's otherwise allowable itemized deductions by three percent of the amount by which the taxpayer's adjusted gross income exceeds an applicable threshold. However, the amount of itemized deductions is not reduced by more than 80 percent. Certain items, such as medical expenses, investment interest, and casualty, theft or wagering losses, are excluded.

• The American Taxpayer Relief Act also officially revives the personal exemption phase-out rules, but at applicable income threshold levels slightly higher than in the past:
  o  $300,000 for married couples and surviving spouses;
  o  $275,000 for heads of households;
  o  $250,000 for unmarried taxpayers; and
  o  $150,000 for married taxpayers filing separately.

Under the phase-out, the total amount of exemptions that may be claimed by a taxpayer is reduced by two percent for each $2,500, or portion thereof (two percent for each $1,250 for married couples filing separate returns) by which the taxpayer's adjusted gross income exceeds the applicable threshold level.

Child Credits

• The American Taxpayer Relief Act extends permanently the $1,000 child tax credit. Certain enhancements to the credit under Bush-era legislation and subsequent legislation are also made permanent.

• The American Taxpayer Relief Act extends permanently Bush-era enhancements to the child and dependent care credit. The current 35 percent credit rate is made permanent along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.

Education

• The American Taxpayer Relief Act extends through 2017 the American Opportunity Tax Credit (AOTC). The AOTC is an enhanced, but temporary, version of the permanent HOPE education tax credit.
• The AOTC rewards qualified taxpayers with a tax credit of 100 percent of the first $2,000 of qualified tuition and related expenses and 25 percent of the next $2,000, for a total maximum credit of $2,500 per eligible student. Additionally, the AOTC applies to the first four years of a student's post-secondary education.
• The American Taxpayer Relief Act makes permanent or extends a number of enhancements to tax incentives designed to promote education. Many of these enhancements were made in Bush-era legislation, extended by subsequent legislation and are scheduled to expire after 2012. Some enhancements, notably the American Opportunity Tax Credit, had been made in President Obama's first term.
• Deduction for Qualified Tuition and Related Expenses-The American Taxpayer Relief Act extends until December 31, 2013 the above-the-line deduction for qualified tuition and related expenses. The bill also extends the deduction retroactively for the 2012 tax year.
• Student Loan Interest Deduction- The American Taxpayer Relief Act also expands the modified adjusted gross income range for phase-out of the deduction permanently and repeals the restriction that makes voluntary payments of interest nondeductible permanently.
• Employer-Provided Education Assistance-The American Taxpayer Relief Act extends permanently the exclusion from income and employment taxes of employer-provided education assistance up to $5,250.

More Individual Tax Extenders

• Teachers' Classroom Expense Deduction-The American Taxpayer Relief Act extends through 2013 the teacher's classroom expense deduction. The deduction, which expired after 2011, allows primary and secondary education professionals to deduct (above-the-line) qualified expenses up to $250 paid out-of-pocket during the year.
• Exclusion of Cancellation of Indebtedness on Principal Residence-Cancellation of indebtedness income is includible in income, unless a particular exclusion applies. This provision excludes from income cancellation of mortgage debt on a principal residence of up $2 million. The American Taxpayer Relief Act extends the provision for one year, through 2013.
• Mortgage Insurance Premiums-This provision treats mortgage insurance premiums as deductible interest that is qualified residence interest. The American Taxpayer Relief Act extends this provision through December 31, 2013. The provision originally expired after 2011.
• IRA Distributions to Charity-The American Tax Relief Act extends for two years, through December 31, 2013, the provision allowing tax-free distributions from individual retirement accounts to public charities, by individuals age 701/2 or older, up to a maximum of $100,000 per taxpayer per year. The Act provides special transition rules. One rule allows taxpayers to recharacterize distributions made in January 2013 as made on December 31, 2012. The other rule permits taxpayers to treat a distribution from the IRA to the taxpayer made in December 2012 as a charitable distribution, if transferred to charity before February 1, 2013.

BUSINESS TAX PROVISIONS

Code Section 179 Expensing and Bonus Depreciation

• Small Business Expensing-The American Taxpayer Relief Act extends through 2013 enhanced Code Section 179 small business expensing. The dollar limit for tax years 2012 and 2013 is $500,000 with a $2 million investment limit. The rule allowing off-the shelf computer software is also extended.
• The American Taxpayer Relief Act extends 50 percent bonus depreciation through 2013. Some transportation and longer period production property is eligible for 50 percent bonus depreciation through 2014.
• Bonus depreciation also relates to the vehicle depreciation dollar limits under Code Section 280F which imposes dollar limitations on the depreciation deduction for the year in which a taxpayer places a passenger automobile in service within a business, and for each succeeding year.  

Research Tax Credit

• The American Taxpayer Relief Act extends through 2013 the Code Section 41 research tax credit, which expired after 2011. The incentive rewards taxpayers that engage in qualified research activities with a tax credit.
• Commonly called the research or research and development credit, the incremental research credit may be claimed for increases in business-related qualified research expenditures and for increases in payments to universities and other qualified organizations for basic research. The credit applies to excess of qualified research expenditures for the tax year over the average annual qualified research expenditures measured over the four preceding years.

FEDERAL ESTATE AND GIFT TAX PROVISIONS

• The American Taxpayer Relief Act permanently provides for a maximum federal estate tax rate of 40 percent with an annually inflation-adjusted $5 million exclusion for estates of decedents dying after December 31, 2012.
• The maximum estate tax rate for estates of decedents dying after December 31, 2010 and before January 1, 2013 is 35 percent with a $5 million exclusion (indexed for inflation for 2012 at $5.12 million). Effective January 1, 2013, the maximum federal estate tax rate was scheduled to revert to 55 percent with an applicable exclusion amount of $1 million (not indexed for inflation), its levels before enactment of estate tax reform in 2001 and subsequent legislation.
• The American Taxpayer Relief Act makes permanent "portability" between spouses. Prior to the permanent extension, portability was only available to the estates of decedents dying after December 31, 2010 and before January 1, 2013.

Portability allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent's unused exclusion (the deceased spousal unused exclusion amount (DSUE)) to the surviving spouse's own transfers during life and at death.

• The American Taxpayer Relief Act provides a 40 percent tax rate and a unified estate and gift tax exemption of $5 million (inflation adjusted) for gifts made after 2012.
• The 2010 Tax Relief Act provided that for gifts made after December 31, 2010, the gift tax was reunified with the estate tax, with a tax rate through 2012 of 35 percent and an applicable lifetime unified exclusion amount of $5 million (adjusted annually for inflation).



Thanks to Flynn and Co. for this well-written and timely guest article. 

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Terry Weaver

CEO

Chief Executive Boards International
http://www.chiefexecutiveboards.com/

TerryWeaver@ChiefExecutiveBoards.com