January 4, 2013
Happy New Year! We hope everyone had a great holiday season. As we closed 2012, American businesses and individuals were faced with significant uncertainty related to future taxes. We went right to the edge of the “Fiscal Cliff” before Congress approved the American Taxpayer Relief Act of 2012, providing a merciful end to a great deal of uncertainty for American taxpayers. So what does the Act mean for you? That depends on who you are. Many tax breaks were extended, including some valuable business incentives. In some cases tax breaks were allowed to expire, while new taxes will also take effect. Here’s a summary of what the Act means to both individuals and businesses for 2013 and beyond.
The American Taxpayer Relief Act permanently extended many middle-class tax cuts, extended some credits for families, allowed some benefits to expire, while increasing taxes on some taxpayers.
First, the top individual income tax rate was increased from 35% to 39.6% as expected. This rate applies to taxable income in excess of $400,000 for individuals and $450,000 for married couples. The Act also reduced the availability of certain deductions for individuals making over $250,000 in income and couples making over $300,000. These include a phase-out of allowable itemized deductions and a phase-out of the Personal Exemption. The provisions essentially return tax rates for “high income” earners to levels more in line with the 1990s. Together, the increase in the tax rate and decrease in allowable deductions may mean significant tax increases for certain individuals, placing higher importance on tax planning for all individuals and any available business incentives for business owners.
Other tax increases were also instituted, as capital gains rates and preferred dividend rates increased from 15% to 20%. These affect income on investments. Additionally, a new 3.8% Medicare surcharge on investment income, created by recent healthcare legislation, has also gone into effect. That means investment income may now be taxed an additional 8.8% over 2012 levels. This increases the importance of retirement planning and asset management going forward.
One important, and in some circles unexpected, aspect of the bill was the extension of the $5 million estate and gift tax exemption for individuals ($10 million for couples). Without the new legislation, the exemption would have decreased to $1 million in 2013 and beyond, creating significant, additional tax liability for certain estates and causing particular problems for estates including businesses, properties, and other non-liquid assets. While the taxpayer friendly exemption levels were extended, the estate tax rate increased from 35% to 40%. So estates valued in excess of the exemption levels will now be taxed an additional 5% beyond exempted amounts. While many taxpayers took the steps necessary to take advantage of these provisions before the end of 2012, the new legislation provides another window for planning. If you missed your opportunity to plan in 2012, it is important that you act soon to capitalize on the historically high exemption levels, as there is no guarantee these will remain in place in the future.
One of the most far-reaching changes was a permanent fix to the alternative minimum tax (AMT) problem. The Act will help millions of Americans avoid paying AMT, and will keep Congress from needing to continue to pass an “AMT patch” every year. Original AMT exemption levels (which determine income levels which are not subject to AMT) were set when the AMT was first introduced into the tax code, and did not adjust automatically for inflation. Accordingly, Congress was required to increase the exemption amounts for each tax year in order to prevent millions of middle-class Americans from being subject to a tax intended for higher income earners. Specifically, the Act raised the AMT exemptions in 2012 from $33,750 to $50,600 for single taxpayers and from $45,000 to $78,750 for married couples. The Act also provides for automatic adjustments for AMT exemption levels each year to account for inflation, meaning taxpayers won’t have to rely on an act of Congress each year to keep them from being ensnared by AMT. The result is that many middle-class taxpayers will have more certainty in their tax planning and greater ability to use certain tax credits and deductions that can’t offset the AMT.
As expected, the Payroll Tax Holiday of 2011 and 2012 was allowed to expire. That means the employee portion of payroll tax will now increase from 4.2% back to 6.2% immediately. Almost all taxpayers will see an immediate decrease in take home pay in 2013 from this return to standard rates.
The Act also temporarily extended the IRA “charitable rollover,” a rule that allows people 70.5 and older to transfer as much as $100,000 per year from their traditional IRAs to charity. While the provision had lapsed in 2012, the Act provides a window through January 31, 2013 for 2012 donations and also extends the provision through the end of 2013. With traditional IRAs, account owners must take taxable yearly required distributions starting at age 70.5. With the “charitable rollover,” account holders can transfer funds directly to a charity, meet withdrawal requirements, and avoid tax. If you have previously taken advantage of the IRA charitable rollover and want to do so again for the 2012 tax year, it is imperative that you act quickly.
Other changes affecting individuals include a one year extension of emergency unemployment benefits, and the expansion of the Child Tax Credit, Earned Income Tax Credit, and American Opportunity Credit.
The Act extended a number of business incentives that many small and medium sized businesses rely on. While most extensions were temporary, the Act provided continued incentives for some specific business activities. First, the Research Tax Credit, which rewards companies for investing in the development of new and improved products and processes, was extended through 2013. The credit was also retroactively made available for 2012, meaning there will be no lapse in availability. The Work Opportunity Credit, which provides incentives to businesses for hiring certain workers, was also extended for another year. Businesses will need to be sure to stay up to date with worker qualifications and credit amounts to ensure they remain compliant and take maximum advantage of these credits.
Several valuable incentives for investment were also extended, as Congress voted to keep the Section 179 deduction and phase out levels consistent with 2010 and 2011 levels. Businesses may expense purchases of qualifying assets placed in service during 2012 and 2013 up to $500,000 with a phase out amount beginning at $2,000,000. Congress also decided to extend the 50% Bonus Depreciation for qualifying assets purchased and placed in service before January 1, 2014. What do these two incentives mean for business? They mean that Congress is still trying to stimulate business spending (especially small business) by providing incentives for purchasing capital assets. So 2013 remains a good time to make planned capital investments, as these specific incentives will provide significant tax relief.
As previously mentioned in the individual section, the Payroll Tax Holiday of 2011 and 2012 was allowed to expire. Employees’ portion of payroll tax will now increase from 4.2% back to 6.2% immediately. Almost all taxpayers will see an immediate decrease in take home pay in 2013 from this return to standard rates. Businesses may want to consider notifying their employees of this tax change to avoid the perception of reduced pay.
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