Happy New Year Indeed - Congress Passes Compromise Tax Legislation
Early in the morning of January 1, while many Americans were still celebrating New Year’s Eve, the U.S. Senate passed the “American Taxpayer Relief Act” (ATRA) to avert the most dire of the effects of the so-called “fiscal cliff.” The U.S. House of Representatives, by a vote of 257 to 167, later also passed ATRA. President Obama is expected to sign the ATRA into law in short order. This alert is meant to highlight some of the key provisions of ATRA as they affect nearly every U.S. taxpayer.
- Income Tax Rate Increase for “High Earners”. ATRA includes a compromise on the top income tax rate that was a hallmark of the recent elections. While most taxpayers will not see an increase in their marginal tax rates, a 39.6% top rate will once again apply to “high earners” with income above a certain threshold. The applicable threshold is $400,000 for single filers; $425,000 for heads of household; $450,000 for joint filers and surviving spouses; and $225,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Like other tax rates, these dollar amounts will be inflation-adjusted for tax years after 2013.
- Top Capital gain and Qualified Dividend Rates also Rise for “High Earners”. The top rate for long-term capital gains, as well as qualified dividends, will permanently rise to 20% from the current 15% rate for high earners in the income tax brackets noted above. This is in addition to the 3.8% Medicare surtax on investment-type income and gains for tax years beginning after 2012. The overall rate for higher-income taxpayers on these types of income will now be 23.8%, an increase of nearly 60% in the taxes due thereon. The 0% rate on these types of income is now permanent for taxpayers whose ordinary income tax rate is less than 25%. Taxpayers in the middle of these income ranges will continue to enjoy the 15% rate on qualified dividends and long-term capital gains (unless they are also subject to the 3.8% Medicare surtax).
- Social Security Tax Holiday Ends. The temporary 2% decrease in the employee-paid portion of Social Security enjoyed in 2012 is now at an end. Accordingly, any taxpayer earning wages or other income subject to Social Security taxes will see a reversion to the prior tax rate, resulting in a small increase in that tax liability going forward (compared to 2012).
- PEP and Pease Limitations. For tax years beginning after 2012, the previously suspended Personal Exemption Phaseout (PEP) is reinstated with the phaseout of personal exemptions beginning at the following income thresholds: $250,000 for single filers; $275,000 for heads of household; $300,000 for joint filers and a surviving spouse; and $150,000 for married taxpayers filing separately. Likewise, the “Pease“ limitation on itemized deductions is reinstated for taxpayers in those same income categories. Thus, it can be expected that taxpayers in these income tax brackets may also see an incremental increase in their federal income tax liability.
- Permanent Alternative Minimum Tax Relief. The Act provides permanent alternative minimum tax (AMT) relief by increasing the AMT exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately – such amounts to be indexed for inflation for tax years beginning after 2012. This should now allow Congress to avoid having to "fix" the AMT regime on an annual basis.
- Personal and Business Tax Exclusions and Credits. Numerous personal and business tax credits, as well as certain exclusions and other beneficial provisions, will be extended under ATRA. For individuals, the extended provisions include the American Opportunity tax credit, the treatment of mortgage insurance premiums as qualified residence interest, and the ability to make tax-free distributions from individual retirement plans for charitable purposes. For businesses, the extended provisions include enhanced depreciation recovery (including an extension and modification of the bonus depreciation provisions), a modification and extension through 2013 of the research credit, exclusion of 100% of gain on certain small business stock acquired before January 1, 2014, the extension of various energy-related tax credits, extension of the Subpart F exception for active financing income, and an extension of the reduction in the S Corporation recognition period for built-in gains tax to five years for dispositions occurring in 2012 and 2013.
- Federal Transfer Taxes. The federal estate, generation skipping transfer and gift taxes will remain in effect with a $5 million per person exemption, but with the top marginal tax rate increasing to 40% (from 35% in 2012). Without ATRA, the exemption level would have fallen to $1 million per person with a 55% top tax rate.
Of course, this brief synopsis of ATRA’s key provisions is non-exclusive. As we have a further opportunity to digest all of its provisions, we will be releasing further specific analysis of the act. 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 also refer to the Tax and Estates page on our website, www.whiteandwilliams.com.
If you would like to discuss how any of these changes may affect your business or personal tax planning, or have any other tax or estate planning questions, please contact Bill Hussey (215-864-6257), John Eagan (212-868-4835), Kevin Koscil (215-864-6827) or Suzanne Prybella (215-864-7188).
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.