Individual Tax Provisions of the American Taxpayer Relief Act of 2012
On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA), which President Obama promptly signed into law on January 2, 2013. While ATRA preserved many of the favorable individual income tax rates that were scheduled to expire beginning in 2013, many (if not most) taxpayers will see at least a modest increase in their federal tax burden going forward. The tax increases will be particularly acute among those deemed to be “high earners” under the legislation. The following is an overview of the new individual tax provisions under ATRA.
ATRA has permitted the temporary reduction in the employee paid portion of Social Security taxes, which had been in effect for 2011 and 2012, to expire. For tax years beginning after 2012, the Social Security payroll tax is restored to 6.2% (a 2% increase from the 4.2% rate in 2011 and 2012). Thus, all taxpayers receiving wage, salary or self-employment income will see an increase in their Social Security tax burden.
Individual Tax Rates
Income tax rates for most individuals will remain at 10%, 15%, 25%, 28%, 33% and 35% (instead of rising to 15%, 28%, 31%, 36% and 39.6% as scheduled) for tax years beginning after 2012. However, a 39.6% rate will apply to taxable income above a certain threshold. The applicable threshold is $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. The applicable thresholds are inflation-adjusted for tax years after 2013.
Capital Gains & Qualified Dividends Rate
For tax years beginning after 2012, the top marginal income tax rate for capital gains and qualified dividends will permanently rise to 20% (up from the previous 15%) for taxpayers with taxable incomes exceeding the following thresholds: $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. Taxpayers who are subject to a rate of 25% or greater on ordinary income, but whose taxable income levels fall below the aforementioned applicable thresholds will continue to be subject to a 15% rate on capital gains and dividends. Taxpayers who are subject to a rate below 25% on ordinary income will be subject to a 0% rate on capital gains and dividends. The previously enacted 3.8% Medicare surtax on net investment income for tax years beginning after 2012 remains unchanged and will also apply to amounts earned in excess of specified thresholds.
Personal Exemptions Phase-Out (PEP)
A personal exemption amount is generally allowed for each taxpayer, his or her spouse, and any dependents in computing taxable income. However, for tax years beginning after 2012, the total amount of exemptions that can be claimed by a taxpayer is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold (personal exemption phase-out). The applicable threshold is $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. These dollar amounts are inflation-adjusted for tax years after 2013.
Itemized Deduction Limitations (“Pease Limitation”)
In lieu of taking the standard deduction, a taxpayer may take itemized deductions. However, for tax years beginning after 2012, the total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer's AGI exceeds a threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The applicable threshold is $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. These dollar amounts are inflation-adjusted for tax years after 2013.
The alternative minimum tax (AMT) is the excess of the tentative minimum tax for the year over the regular income tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income, which is subject to an AMT rate of 26% or 28%. Retroactively effective for tax years beginning after 2011, the AMT exemption amounts are permanently increased as follows: $50,600 for unmarried individuals; $78,750 for married couples filing jointly and surviving spouses; and $39,375 for married individuals filing separately. These exemption amounts are indexed for inflation for tax years beginning after 2012. The indexing of the exemption amount is meant to solve the issue of requiring Congress to annually pass an “AMT Fix” to prevent millions of additional taxpayers from becoming subject to the AMT.
Kiddie Tax Implications. For tax years beginning after 2011, for a child subject to the kiddie tax, the AMT exemption amount can't exceed the sum of the child's earned income plus an annually adjusted amount ($6,950 for 2012, $7,150 for 2013). In addition, the kiddie tax AMT exemption can't be more than the child's regular (unmarried individual) AMT exemption.
Personal Nonrefundable Tax Credits. Retroactively effective for tax years beginning after 2011, an individual is permitted to offset AMT liability by using nonrefundable personal credits. In the past, an individual’s ability to do so had been limited.
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). ATRA provides a five-year extension of the expanded AOTC, allowing it to be claimed in tax years after 2008 and before 2018.
Child Tax Credits (CTC). The CTC allows taxpayers to claim a tax credit for each qualifying child under age 17 that the taxpayer can claim as a dependent. The CTC phases out when taxpayers' income exceeds certain thresholds. The maximum CTC is now permanently set at $1,000 and is partially refundable for eligible taxpayers. In addition, ATRA provides a five-year extension of certain liberalized rules on refundability (enacted by the American Recovery and Reinvestment Act of 2009), rendering them applicable in tax years after 2008 and before 2018.
Earned Income Tax Credit (EITC). Certain low-income workers are allowed a refundable EITC. The credit is equal to a percentage of the taxpayer's earned income. However, as the taxpayer’s income increases, the credit is phased out. The maximum EITC amount depends on the number of a taxpayer’s qualifying children. The statutory earned income amounts are increased annually for inflation, and phase out amounts limit the amount of the credit. ATRA provides a five-year extension of certain favorable EITC rules (enacted by the American Recovery and Reinvestment Act of 2009) rendering them applicable to tax years after 2008 and before 2018.
Educator Expenses. Eligible elementary and secondary school teachers may claim an above-the-line deduction for up to $250 per year of expenses paid or incurred for books, certain supplies, computer and other equipment, and supplementary materials used in the classroom. ATRA retroactively extends this deduction such that it applies to expenses paid or incurred in tax years 2012 and 2013.
State and Local Sales Tax. For tax years beginning before January 1, 2014, taxpayers who itemize deductions (rather than taking the applicable standard deduction) may elect to itemize and deduct state and local general sales and use taxes instead of state and local income taxes. Thus, residents of states such as Florida that do not have a general income tax, may benefit by itemizing their deductions.
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.
Mortgage Insurance Premiums. Mortgage insurance premiums paid or accrued before January 1, 2014 by a taxpayer in connection with acquisition indebtedness with respect to the taxpayer's qualified residence are treated as deductible qualified residence interest, subject to a phase-out based on the taxpayer's AGI.
Miscellaneous Tax Breaks
Home Mortgage Debt Exclusion. Discharge of indebtedness income from qualified principal residence debt, up to $2 million ($1 million for married individuals filing separately) is excluded from gross income, provided that such home mortgage debt is discharged before 2014.
Employer Provided Mass Transit/Parking Benefits. Through 2013, an employee can exclude from gross income up to $245 per month in employer-provided mass transit and parking benefits.
Qualified Conservation Contributions. Applicable to contributions made before January 1, 2014, a taxpayer's aggregate qualified conservation contributions (i.e., contributions of appreciated real property for conservation purposes) 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.
Eligibility Determination for Certain Benefits
Code Sec. 6409 provides that for purposes of determining a taxpayer's eligibility for benefits or assistance under any federal program or federally-financed state or local program, any refunds made to the taxpayer aren't taken into account as income or resources for a 12-month period after receipt. ATRA removed the termination date from this code section and made this code section permanent, such that it now applies to amounts received after December 31, 2012.
Retirement Plan Transfers to Roth Accounts
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. The amount converted is included in the taxpayer's income in the year of the conversion, but future distributions from the Roth IRA are tax-free (including any appreciation on the amounts transferred). For transfers after December 31, 2012 (in tax years ending after that date), plan provisions which include a qualified Roth contribution program can allow participants to elect to transfer amounts to designated Roth accounts with such transfers being treated as a taxable qualified rollover contribution.
IRA Transfers to Charities
Retroactively applicable to charitable IRA transfers made in tax years beginning before January 1, 2014, taxpayers age 70½ or older can make tax-free distributions to a charity from an IRA of up to $100,000 per year. In addition, 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.
We would be remiss if we did not mention that ATRA may not yet be the end of the tax law changes to come in 2013. Members of Congress and the President’s administration have each stressed that they intend to seek further revenue – i.e., tax – increases in the coming debt ceiling negotiations. Therefore, and notwithstanding the “permanent” language contained in ATRA with respect to certain tax provisions, it would not be surprising if the tax increases represented by ATRA were further extended in the coming months.
As always, the Tax and Estates Practice Group at White and Williams is committed to keeping our clients and friends up to date with important tax developments. For current information, please refer to the Tax and Estates page on our website, www.whiteandwilliams.com.
IRS Circular 230 Notice: To ensure compliance with certain regulations promulgated by the U.S. Internal Revenue Service, we inform you that any federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code, or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein, unless expressly stated otherwise.