The American Taxpayer Relief Act 1-9-13
January 9, 2013
Happy New Year!
The American Taxpayer Relief Act (2012 Act) was signed into law on January 2, 2013. This is the most comprehensive tax act that has been enacted in over a decade and affects all taxpayers. The 2012 Act also provides new estate and gift tax provisions that permanently extend provisions that were supposed to expire as of December 31, 2012.
We want to provide a summary of the provisions that will apply to our clients. The 2012 Act includes many other provisions that apply to certain financing arrangements, special production expenses, tax treatment of certain regulated investment companies and certain tax credits that our clients have not been involved with in the past. We are not including information about these provisions in this summary but will be happy to share with you if you are interested in learning more about them.
We encourage you to contact us to discuss any questions that you have to determine how the new legislation will affect your 2012 Federal income tax return and what planning opportunities should be considered to prepare for future tax years. The 2012 Act prevents many of the scheduled tax hikes and retains many favorable tax breaks that were set to expire in 2012 and subsequent years, but it also increases income taxes for some higher-income individuals and slightly increases transfer tax rates.
The new law provides that the income tax rates for most individuals will stay at 10%, 15%, 25%, 28%, 33% and 35%. However, a 39.6% rate will apply to taxable income in excess of the “applicable threshold” over the dollar amount at which the 35% bracket begins.
Applicable threshold: $450,000 for joint filers & surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. These dollar amounts are inflation-adjusted for tax years after 2013.
Capital Gains & Qualified Dividends Rates
For taxpayers generally taxed at a rate below 25%, long term capital gains and qualified dividends will permanently be subject to a 0% rate. Taxpayers generally taxed at rates equal to or greater than 25%, but whose taxable income levels fall below the applicable threshold (above), will be subject to a 15% rate on capital gains and qualified dividends. For taxpayers with taxable incomes exceeding the applicable threshold, long term capital gains and qualified dividends will be permanently taxed at 20% (up from 15%).
In addition to the capital gains tax, there will be a 3.8% surtax on investment-type income and capital gains for taxpayers whose modified adjusted gross income is over a certain amount (over $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separately, and $200,000 in any other case).
Phase-Out of Personal Exemptions & Limitation on Itemized Deductions for Higher-Income Taxpayers
For tax years beginning after 2012, personal exemptions will be phased out for higher-income taxpayers whose adjusted gross income exceeds the applicable threshold. For tax years beginning after 2012, itemized deductions will be reduced by 3% of the amount by which a taxpayer's AGI exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions.
Threshold for both provisions: $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married taxpayers filing separately.
Exclusion of 100% of Gain on Certain Small Business Stock
A taxpayer may exclude all of the gain on the disposition of qualified small business stock acquired after September 27, 2010 and before January 1, 2012. The 2012 Act retroactively extends this provision for two years so that taxpayers may exclude 100% of gain from the disposition of qualified small business stock acquired after September 27, 2010 and before January 1, 2014. Based upon a recent court case in California, this exclusion will no longer be available for California tax purposes, for sales of qualified small business stock starting in tax year 2008 and subsequent years.
Nontaxable IRA Transfers to Eligible Charities
For tax years beginning before January 1, 2014, taxpayers who are age 70 1/2 or older can make tax-free distributions to a charity from an Individual Retirement Account (IRA) of up to $100,000 per year. These distributions aren't subject to the charitable contribution percentage limits since they are neither included in gross income nor claimed as a deduction on the taxpayer's return.
The Act includes two elections to deal with the retroactive reinstatement of this provision: (1) A taxpayer may elect to have a distribution made in January of 2013 be treated as if it were made on December 31, 2012. (2) A taxpayer may elect to treat any portion of a distribution from an IRA to the taxpayer during December of 2012 as a qualified charitable distribution, provided that (i) the portion is transferred in cash after the distribution to an eligible charitable organization before Feb. 1, 2013, and (ii) except for the fact that the distribution wasn't originally transferred directly to the organization, the distribution otherwise meets Code Sec. 408(d)(8)'s requirements.
Exclusion for Discharged Home Mortgage Debt
The provision that excludes from gross income the forgiveness of a qualified principal residence debt, up to a $2 million limit ($1 million for married individuals filing separately), is extended so that it applies to home mortgage debt discharged before 2014. The exclusion applicable for California tax purposes is limited to $500,000.
Excludible Employer-Provided Mass Transit and Parking Benefits
The 2012 Act retroactively increases the monthly exclusion for employer-provided transit and vanpool benefits to equal the exclusion amount for employer-provided parking benefits through 2013. For 2012, the exclusion is amount $240. Indexed for inflation, the exclusion amount is $245 per month in 2013.
Above-the-Line Deduction for Higher Education Expenses
For tax years beginning before January 1, 2014, a taxpayer may claim an above-the-line deduction for qualified tuition and related expenses for higher education paid by that taxpayer during the tax year, subject to applicable adjusted gross income (AGI) and dollar limits.
Treatment of Mortgage Insurance Premiums as Deductible Qualified Residence Interest
The 2012 Act retroactively extends the provision that allows a taxpayer to deduct (subject to a phase-out based on the taxpayer's AGI), as qualified residence interest, mortgage insurance premiums paid or accrued before January 1, 2014. The premiums must be paid or accrued in connection with acquisition indebtedness with respect to the taxpayer's qualified residence. The State of California does not conform to this deduction.
State and Local Sales Tax Deduction
For tax years beginning before January 1, 2014, taxpayers who itemize deductions may elect to deduct state and local general sales and use taxes instead of state and local income taxes.
Qualified Conservation Contributions
A taxpayer's aggregate qualified conservation contributions (i.e., contributions of appreciated real property for conservation purposes) made in tax years beginning before January 1, 2014 are allowed up to the excess of 50% of the taxpayer's contribution base over the amount of all other allowable charitable contributions (100% for qualified farmers and ranchers), with a 15-year carryover of such contributions in excess of the applicable limitation.
AMT Exemption & Personal Nonrefundable Credits
Retroactively effective for tax years beginning after 2011, the new law permanently increases the AMT exemption amounts; and the law indexes the exemption amounts for inflation for tax years beginning after 2012. Also retroactively effective for tax years beginning after 2011, the new law permanently allows an individual to offset his regular tax liability and AMT liability by the nonrefundable personal credits.
American Opportunity Tax Credit (AOTC)
The AOTC allows eligible taxpayers to claim a credit equal to 100% of the first $2,000 of qualified tuition and related expenses, and 25% of the next $2,000 of qualified tuition and related expenses (for a maximum tax credit of $2,500 for the first four years of post-secondary education). The 2012 Act provides an extension of the AOTC, allowing it to be claimed in tax years after 2008 and before 2018.
Child Tax Credit
The Child Tax Credit allows taxpayers to claim a tax credit for each qualifying child under age 17 that the taxpayer can claim as a dependent. The 2012 Act makes the $1,000 per-child credit amount permanent.
The credit phases out when taxpayers' income exceeds certain thresholds.
Transferring from Applicable Retirement Plans to Designated Roth Accounts
Under current law, a taxpayer with an applicable retirement plan which includes a qualified Roth IRA contribution plan can transfer amounts to a Roth IRA account but only to the extent that the taxpayer had a right to remove such amounts from the plan (e.g., because he had attained age 59 1/2).
For transfers after December 31, 2012, in tax years ending after that date, plan provisions in an applicable retirement plan which includes a qualified Roth contribution program can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution.
New Permanent Indexed Exemption for Gift and Estate Taxes
The 2012 Act permanently establishes the estate, gift, and generation-skipping transfer (GST) tax exemption amount at $5 million per person (as increased by indexing after 2011). Indexing increased the exemption to $5,120,000 for 2012. Based on indexing, the exemption amount for 2013 is expected to be $5,250,000.
Transfer Tax Rates
The maximum estate and gift tax rate was 35% for gifts made and decedents dying in 2012. The 2012 Taxpayer Relief Act changes the top rate to 40% for gifts made and decedents dying after 2012. Under the Act, transfers over $500,000 are taxed at 37%, transfers over $750,000 are taxed at 39% and transfers over $1,000,000 are taxed at 40%. The top GST tax rate is also 40%.
Portability of Unused Exemption between Spouses
The 2012 Taxpayer Relief Act makes permanent the provision that allows for the transfer of any unused exclusion to the surviving spouse. The amount received by the surviving spouse is called the deceased spousal unused exclusion, or DSUE, amount. If the executor of the decedent's estate elects transfer, or portability, of the DSUE amount, the surviving spouse can apply the DSUE amount received from the estate of his or her last deceased spouse against any tax liability arising from subsequent lifetime gifts and transfers at death.
The new law retroactively extends the research credit for two years so that it applies for amounts paid or accrued before January 1, 2014.
For tax years beginning after December 31, 2011, the 2012 Act liberalizes the research credit rules for persons that acquire the major portion of either a trade or business or a separate unit of a trade or business of another person. Here, for purposes of calculating the allowable research credit, the amount of qualified research expenses paid or incurred by the acquiring person during the measurement period is increased by certain expenses of the predecessor, and the gross receipts of the acquiring person for such period is increased by certain gross receipts of the predecessor. The measurement period is, with respect to the tax year of the acquiring person for which the research credit is determined, any period of the acquiring person preceding such tax year which is taken into account for purposes of determining the credit for such year.
The 2012 Act also revises the rules for allocating the research credit among members of a controlled group or members of a group of commonly controlled trades or businesses. For tax years beginning after December 31, 2011, the credit for each member of a controlled group is determined on a proportionate basis to its share of the aggregate of the qualified research expenses, basic research payments, and amounts paid or incurred to energy research consortiums, taken into account by such controlled group for purposes of the research credit. A similar rule applies to members of a group of commonly controlled trades or businesses.
Bonus First-Year Depreciation
The 2012 Act extends the 50% first-year bonus depreciation so that it applies to qualified property acquired and placed in service before January 1, 2014 (before Jan. 1, 2015 for certain longer-lived and transportation property). California does not provide for any bonus first year depreciation.The 2012 Act also extends through 2013 the rule treating qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property as 15-year property. Thus, such property is eligible for a bonus 50% first-year depreciation deduction if placed in service before January 1, 2014.
First-Year Depreciation Cap for 2013 Autos and Trucks Boosted by $8,000
Under the luxury auto dollar limits of Code Sec. 280F, depreciation deductions (including Code Sec. 179 expensing) that can be claimed for passenger autos are subject to dollar limits that are annually adjusted for inflation. For passenger automobiles placed in service in 2012, the adjusted first-year limit is $3,160. For light trucks or vans, the adjusted first-year limit is $3,360.
The applicable first-year depreciation limit is increased by $8,000 (not indexed for inflation) for any passenger automobile that is “qualified property” under the bonus depreciation rules and which isn't subject to a taxpayer election to decline bonus depreciation.
The 2012 Act provides that the placed-in-service deadline for “qualified property” is December 31, 2013 (December 31, 2014 for aircraft and long-production-period property).
Choice to Forego Bonus Depreciation and Claim Credits Instead
Pre-Act law's Code Sec. 168(k)(4) generally permits a corporation to increase the AMT credit limitation (but not the research credit limitation) by the bonus depreciation amount with respect to certain property placed in service after December 31, 2010 and before January 1, 2013 (January 1, 2014 in the case of certain longer-lived and transportation property). The new law provides similar options to corporations for property placed in service after December 31, 2012 and before 2014 (before 2015 for the aircraft and long-production-period property), in tax years ending after that date.
Boosted Expensing Amounts for 2013
Retroactively effective for tax years beginning in 2012, the 2012 Act increases the maximum expensing amount under Code Sec. 179 from $139,000 to $500,000. Effective for tax years beginning in 2013, the new law increases the maximum expensing amount under Code Sec. 179 from $25,000 to $500,000. The 2012 Act also increases the investment-based phase-out amount for tax years beginning in 2012 or 2013 to $2,000,000. However, for tax years beginning after 2013, the maximum expensing amount is scheduled to drop to $25,000 and the investment-based phase-out amount is scheduled to drop to $200,000. California does not conform to these provisions. The maximum expensing amount remains at $25,000 per year.
The Act also provides that:
1. Off-the-shelf computer software is expensing-eligible property if placed in service in a tax year beginning before 2014.
2. For tax years beginning before 2014, an expensing election or specification of property to be expensed may be revoked without IRS's consent. But, if such an election is revoked, it can't be reelected.
3. For any tax year beginning in 2010, 2011, 2012, or 2013, up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) is eligible for expensing under Code Sec. 179.
Work Opportunity Tax Credit
The work opportunity tax credit (WOTC) allows employers who hire members of certain targeted groups to get a credit against income tax of a percentage of first-year wages and, in certain cases first two years’ wages. The credit has been retroactively extended so that it applies to eligible veterans and nonveterans who begin work for the employer before January 1, 2014.
Extension and Modification of Reduction in S Corp Recognition Period for Built-In Gains Tax
Where a corporation that was formed as a C corporation elected to become an S corporation (or where an S corporation receives property from a C corporation in a nontaxable carryover basis transfer), the S corporation is taxed at the highest corporate rate (currently 35%) on all gains that were built-in at the time of the election if the gain is recognized during a recognition period.
Under pre-Act law, for S corporation tax years beginning in 2011, no tax is imposed on the net unrecognized built-in gain of an S corporation if the fifth year in the recognition period preceded the 2011 tax year.
The 2012 Act provides that for determining the net recognized built-in gain for tax years beginning in 2012 or 2013, the recognition period is the 5-year period beginning with the first day of the first tax year for which the corporation was an S corporation.
Empowerment Zone Tax Breaks Reinstated and Extended
The designation of an economically depressed census tract as an “Empowerment Zone” renders businesses and individual residents within such a Zone eligible for special tax incentives. The 2012 Act extends for two years, through December 31, 2013, the period for which the designation of an empowerment zone is in effect.
Enhanced Deduction for Food Inventory Reinstated and Extended
A C corporation may claim an enhanced charitable contribution deduction equal to the lesser of (a) basis plus half of the property's appreciation, or (b) twice the property's basis, for contributions of food inventory that was apparently wholesome food, i.e., meant for human consumption and meeting certain quality and labeling standards. The enhanced contribution is also available for a taxpayer other than a C corporation, but the aggregate amount of contributions of apparently wholesome food that may be taken into account for the tax year can't exceed 10% of the taxpayer's aggregate net income for that tax year from all trades or businesses from which those contributions were made for that tax year. Under pre-Act law, this enhanced charitable deduction didn't apply for contributions after Dec. 31, 2011.
The 2012 Taxpayer Relief Act retroactively extends the apparently wholesome food contribution rules for two years to include contributions made before Jan. 1, 2014.
The 2012 Taxpayer Relief Act did not extend the enhanced deduction for charitable contributions of books (this deduction ceased to apply for contributions made after Dec. 31, 2011), or the enhanced deduction for corporate contributions of computer equipment for educational purposes (this deduction ceased to apply for contributions made during any tax year beginning after Dec. 31, 2011).
New Markets Tax Credit Reinstated and Extended
A new markets tax credit applies for qualified equity investments to acquire stock in a community development entity (CDE). The credit is: (1) 5% for the year in which the equity interest is purchased from the CDE and for the first two anniversary dates after the purchase (for a total credit of 15%), plus (2) 6% on each anniversary date thereafter for the following four years (for a total of 24%). Under pre-Act law, there was a $3.5 billion cap on the maximum annual amount of qualifying equity investments for 2010 and 2011; a carryover was allowed where the credit limitation for a calendar year exceeded the aggregate amount allocated for the year, but no amount could be carried over to any calendar year after 2016.
The 2012 Taxpayer Relief Act retroactively extends the new markets tax credit two years, through 2013. It provides that a $3.5 billion cap applies for 2010, 2011, 2012, and 2013, but no amount can be carried over to any calendar year after 2018.
Expensing Election for Costs of Film and TV Production Extended
Taxpayers may elect to expense production costs of qualified film and television (TV) productions in the U.S. Expensing doesn't apply to the part of the cost of any qualifying film or TV production that exceeded $15 million for each qualifying production. The limit is $20 million if production expenses were “significantly incurred” in areas (1) eligible for designation as a low-income community or (2) eligible for designation by the Delta Regional Authority (a federal-state partnership covering parts of certain states) as a low-income community or isolated area of distress.
Under pre-Act law, these rules applied for qualified film and TV productions beginning before Jan. 1, 2012.
The 2012 Taxpayer Relief Act retroactively extends the expensing provision for two years. It applies for qualified film and TV productions beginning before Jan. 1, 2014.
Lower Shareholder Basis Adjustments for Charitable Contributions by S Corporations
Before the Pension Protection Act of 2006 (PPA), if an S corporation contributed money or other property to a charity, each shareholder took into account his pro rata share of the fair market value of the contributed property in determining his own income tax liability. The shareholder reduced his basis in his S stock by the amount of the charitable contribution that flowed through to him. The PPA amended this rule to provide that the amount of a shareholder's basis reduction in S stock by reason of a charitable contribution made by the corporation is equal to his pro rata share of the adjusted basis of the contributed property. Under pre-Act law, the PPA rule did not apply for contributions made in tax years beginning after Dec. 31, 2011.
The 2012 Taxpayer Relief Act retroactively extends the PPA rule for two years so that it applies for contributions made in tax years beginning before Jan. 1, 2014.
We encourage you to contact us to discuss any questions you have regarding the applicability of any of these provisions to your particular circumstances. We will be considering all of these provisions as we prepare your 2012 tax returns and will bring matters to your attention to consider for planning for the 2013 and subsequent tax years. We will also be posting additional information and more in depth explanations regarding these provisions on our website and Facebook pages. Please visit these sites for additional information regarding the provisions of the 2012 Act and how they may affect you.
We look forward to discussing any questions you have.
Scott B. Price & Company