Income Tax Provisions of the American Taxpayer Relief Act of 2012 and Other Recent Legislation
On January 2, 2013, Congress passed the "American Taxpayer Relief Act of 2012" ("the Act"). Aside from the welcome certainty it provided to the federal estate, gift and generation-skipping transfer ("GST") tax exemptions and rates in 2013, the Act provided for a number of additional changes that affect many taxpayers.
Income Tax Changes Made by the Act
- Individual Income Tax Rates. The Act provides for a top income tax rate of 39.6% (up from 35%) for taxpayers with incomes above $400,000 ($425,000 for heads of household, and $450,000 for joint filers). The Act also provides for an income tax rate of 39.6% for trusts and estates with taxable incomes over $11,950.
- Capital Gains Rates. The Act provides for a top capital gains and dividends tax rate of 20% (up from 15%) for taxpayers with income above $400,000 ($425,000 for heads of household and $450,000 for joint filers).
- Itemized Deduction ("Pease") Limitation. The Act reinstates the Pease limitation for tax years beginning after 2012. If a taxpayer's adjusted gross income ("AGI") exceeds $300,000 for joint filers, $275,000 for heads of household, $250,000 for single filers or $150,000 for married taxpayers filing separately, the itemized deductions allowable for the year will be reduced by the lesser of (i) 3% of the excess of AGI over the threshold, or (ii) 80% of the amount of itemized deductions allowable for the year.
- Personal Exemption Limitations. The Act reduces the total amount of exemptions that a taxpayer may claim by 2% for each $2,500 (or 2% for each $1,250 for a married couple filing separately) by which the taxpayer's AGI exceeds certain AGI thresholds ($300,000 for joint filers, $275,000 for heads of household, $250,000 for single filers or $150,000 for married taxpayers filing separately).
- Alternative Minimum Tax ("AMT") Relief. The Act increases the 2012 AMT exemption to $78,750 for joint filers, $50,600 for single filers and $39,375 for married taxpayers filing separately. Also, the Act indexes the exemption for inflation and allows nonrefundable personal credits to the full amount of a taxpayer's regular tax and AMT.
- Payroll Tax. For 2011 and 2012, the social security tax rate was reduced from 6.2% to 4.2%. The Act does not extend that reduction and, therefore, the social security tax rate in 2013 and beyond has returned to 6.2%.
- Marriage Penalty Relief. The Act extends all existing marriage penalty relief. The basic standard deduction for married couples filing jointly will continue to be twice the basic standard deduction for single filers.
- State and Local Sales Tax Deduction. The Act extends a taxpayer's right to claim an itemized deduction for the payment of state and local sales taxes in lieu of state and local income taxes (which benefits taxpayers in states such as Florida that do not have an income tax).
- Extension of Individual Retirement Account ("IRA") Charity Distributions. The Act extends for two years the ability of a taxpayer over age 70 ½ to annually distribute up to $100,000 of an IRA account to public charities.
- Extension of $1,000 Per Child Tax Credit. Without passage of the Act, the child tax credit had been scheduled to drop to $500 per child.
- Extension of Various Business Tax Provisions. A number of small and large business related tax provisions that were set to expire were extended by the Act.
The Patient Protection and Affordable Care Act ("PPACA")
In 2010, President Obama signed PPACA into law, which overhauled the United States healthcare system. In order to fund the changes, several additional taxes have been added for high income earners as part of PPACA:
- Additional Medicare Withholding Tax on Wages. Beginning on January 1, 2013, the employee portion of the Medicare tax increased 0.9% from 1.45% to 2.35% for single filers with incomes over $200,000 ($250,000 for joint filers).
- New Medicare Tax on Net Investment Income. Beginning on January 1, 2013, a 3.8% tax will be assessed on net investment income (which includes taxable capital gains, dividends, interest, royalties, and rents) for single filers with incomes over $200,000 ($250,000 for joint filers).
What You Can Expect Moving Forward
Additional tax law revisions are being proposed and it is quite possible that we will see further legislation. In light of the changes already enacted, and those perhaps yet to come, it may be appropriate to consider planning strategies for a high income tax environment that involve reducing, shifting and deferring income. Future advisories will discuss these opportunities and we would be pleased to discuss these planning options with you.