Tax Changes in the American Taxpayer Relief Act of 2012

January 4, 2013 11:33 AM

In the dark of night on January 1, Congress finally passed a bill (which the President signed on January 2) that temporarily avoids the worst effects of the “fiscal cliff.” The American Taxpayer Relief Act of 2012 (the “Act”) significantly changes tax rules for individuals and businesses alike. It contains a potpourri of rate changes, extensions of expiring (or expired) provisions, special rules, credits, and other modifications that will affect every taxpayer to a greater or lesser extent. It does not, however, represent even a tiny step towards the significant tax reform that most observers long for. Following is a summary of some of the major provisions of the Act...

  •  Income tax rates. Bush-era tax rates were made permanent for all taxpayers in lower and middle tax brackets. Only the top tax bracket, consisting of individuals with taxable income over $400,000 ($450,000 for married couples filing jointly), will see an increase in rates from 35% to 39.6% on every dollar over that amount. (They will pay the lower rates on money earned in lower brackets, just like everyone else.) The new top bracket is effective for taxable years beginning after December 31, 2012.
  • Capital Gains and Dividends. Taxes on capital gains and certain dividend income for taxpayers in the top bracket ($400,000 of taxable income for individuals and $450,000 for married couples) will permanently increase from 15% to 20% for taxable years beginning after December 31, 2012. For taxpayers in lower tax brackets, the tax rate will remain at 15%.
  • Individual Alternative Minimum Tax. Prior law provided an exemption from the AMT of $33,750 for individuals and $45,000 for married taxpayers filing jointly; these amounts were not indexed for inflation. The Act permanently increases the exemption amounts for 2012 to $50,600 (individuals) and $78,750 (married couples) and provides indexing for inflation for taxable years beginning after December 31, 2012.
  • Itemized Deduction Limitation. Since 1991, the amount of itemized deductions that a taxpayer could claim was reduced to the extent the taxpayer’s AGI exceeded $100,000. The Act repeals this phase-out for individual taxpayers with AGI under $250,000 ($300,000 for married couples) for taxable years beginning after December 31, 2012.
  • Phase-out of Personal Exemptions. The $3,800 personal exemption will phase out for individual taxpayers with AGI above $250,000 ($300,000 for married couples) for taxable years beginning after December 31, 2012.
  • Payroll Tax. The 4.2% reduced payroll tax rate for employees reverts to the 6.2% rate that was in effect prior to 2011.
  • R & D Credit. The tax credit for research and experimentation expenses expired at the end of 2011. The Act extends the credit for two years—retroactively for 2012 and through 2013. The Act also modifies the allocation of expenditures among members of a controlled group and rules for computing the credit when a portion of a trade or business is acquired.
  • Estate & Gift Tax. For the past decade, estate tax rates changed almost annually (and even disappeared entirely in 2010). Prior law exempted the first $5 million of value in an estate with a top tax rate of 35%. The Act makes the $5 million exemption (adjusted for inflation) permanent, but sets the top tax rate at 40% for estates of decedents dying after December 31, 2012. The Act also unified estate and gift taxes, providing for a single exemption and single rate schedule for the two taxes.
  • Roth Conversions. The Act allows taxpayers to convert amounts in certain conventional retirement plans into a Roth account—allowing after-tax contributions with no tax on distributions—without suffering a penalty for early withdrawal. The amount converted, however, would be subject to regular income tax.

Business Tax Provisions

Some other changes that affect business taxation include:

  • Extending 50% bonus depreciation for qualifying property placed in service before January 1, 2014 (or January 1, 2015, for certain long-lived and transportation assets). The Act also allows taxpayers to elect to accelerate some AMT credits in lieu of bonus depreciation for certain types of property.
  • Increasing the limitation for expensing under section 179 rather than depreciating property placed in service during 2013 to $500,000, with a $2 million phase-out amount. The Act also allows taxpayers to expense up to $250,000 of the cost of qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. After 2013, the amounts revert to $25,000 and $200,000, respectively.
  • Allowing look-through for certain payments between related controlled foreign corporations under the foreign personal holding company rules, thereby permitting deferral for the deployment of capital from one CFC to another without triggering U.S. tax. This provision expires after the end of 2013.
  • Extending the temporary exclusion of 100 percent of gain on qualifying small business stock to stock acquired before January 1, 2014, and held for more than five years.
  • Extending numerous expiring provisions through December 31, 2013, including:
  • Subpart F exception for active financing income
  • New markets tax credit
  • Employer wage credit for employees who are active duty members of the uniformed services
  • Work opportunity tax credit
  • 7-year recovery period for motorsports entertainment complexes
  • Election to expense mine safety equipment
  • Special expensing rules for certain film and television production productions
  • Several provisions dealing with cellulosic bio-fuel production

Individual Tax Provisions

Some other changes that affect taxation of individuals include:

  • Extensions through December 31, 2013:
  • Deduction of state and local general sales taxes
  • Exclusion of up to $2 million from gross income on discharge of mortgage indebtedness
  • Above-the-line deduction for qualified tuition and related expenses
  • Tax-free distributions from individual retirement plans for charitable purposes
  • Parity for exclusion from income for employer-provided mass transit and parking benefits
  • Mortgage insurance premiums treated as qualified residence interest
  • Special rule for contributions of capital gain real property made for conservation purposes
  • Credit for energy-efficient existing homes
  • Credit for energy-efficient new homes
  • Credit for energy-efficient appliances
  • Extensions through December 31, 2017:
  • American Opportunity Tax Credit
  • Child Tax Credit
  • Earned Income Tax Credit

James Hedderman
(312) 924-3217

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