By Kira Bravo
Manager, Moss Adams LLP
Courtesy to The Bellingham Business Journal
During the last several months of 2012, elected officials and political pundits debated what to do about the so-called “fiscal cliff”—a combination of higher taxes and spending cuts that would go into effect at the beginning of 2013.
After much wrangling, President Obama and Congress came to an agreement on legislation to address the cliff, and on Jan. 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law.
So what does this mean for you?
Individual Tax Rates
The new law retains the current individual tax rates of 10, 25, 28, 33 and 35 percent, thereby preventing tax hikes for most Americans.
Taxpayers with higher incomes ($400,000 for individuals and $450,000 for married couples filing jointly), however, will now be subject to a tax rate of 39.6 percent. The act doesn’t extend the 2 percent payroll tax holiday that was enacted in 2011, so all wage-earning taxpayers will see their social security withholding increase this year.
Investment Tax Rates
The act keeps the current, favorable long-term capital gains rates of zero percent and 15 percent, but creates a 20 percent rate for individuals with income exceeding $400,000, and $450,000 for married couples filing jointly. The same rates are applied to qualified dividend income.
It’s important to note that individuals with income greater than $200,000 ($250,000 for married couples filing jointly) will also be subject to an additional 3.8 percent surtax on their investment income.
Estate and Gift Implications
The lifetime gift, estate and generation-skipping transfer tax exemption will continue to be $5 million, adjusted for inflation. For 2013, this is $5.25 million.
The act increases the top estate and gift tax rate from 35 percent to 40 percent, which is significantly better than the 55 percent rate originally scheduled for 2013. The act also retains the portability rules, which allows a deceased spouse’s unused exemption to be passed to a surviving spouse and added to his or her lifetime exemption.
Alternative Minimum Tax
The act provides alternative minimum tax relief by increasing the exemption, which is now $78,750 for married couples filing joint tax returns, and will be indexed for inflation in future years. Without the legislation, many more taxpayers would have found themselves subject to the tax when they filed their 2012 return.
Temporary Extensions of Certain Tax Benefits
The following tax benefits were temporarily extended in 2012 and 2013:
– Election to claim itemized deduction for state and local sales taxes
– Itemized deduction for qualified home mortgage insurance premiums
– Exclusion for up to $2 million of debt discharge income from qualified home mortgage forgiveness
– Above-the-line deduction for up to $250 for teachers’ out of pocket classroom expenses
– Deduction for qualified tuition expenses
– Credit for nonbusiness energy property
– Tax-free IRA distributions of up to $100,000 if donated to a charity (may be used to satisfy required minimum distribution requirements)
Permanent Extension of Certain Tax Benefits
The following tax benefits have now been made permanent:
– Income exclusion for adoption assistance
– $1,000 Child Tax Credit per child as well as expanded refundability
– Expanded Child and Dependent Care Credit
– Expanded Adoption Credit
– Beneficial changes to the student loan interest deduction
– $2,000 contribution amount to Coverdell ESAs
Other Individual Tax Changes
Coming back in 2013 are the personal exemption and itemized deduction phase-out rules. For individuals whose income exceeds $250,000 ($300,000 for married couples filing jointly), there will be a limitation on personal exemptions and itemized deductions. This will make income and deduction planning much more important in the future.
Also new in 2013 are eased restrictions on “in-plan” Roth rollovers. This means that if you have been making 401(k) contributions under an employer-provided retirement plan and the plan allows for Roth designated contributions, you are now permitted to convert your 401(k) contributions to a Roth account within the same plan. Please note that the conversion has income tax implications, so a tax professional should be consulted when considering this strategy. Finally, the American Opportunity Tax Credit for higher education expenses was extended through 2017.
Business Tax Implications
The act also provides good news for businesses by extending the following tax benefits through 2013:
– Section 179 depreciation expensing amount of $500,000 (also retroactively extended for 2012)
– 50 percent first-year bonus depreciation
– Accelerated 15-year depreciation for qualified leasehold, retail, and restaurant improvements
– The Work Opportunity Tax Credit for hiring certain employees
– The Research & Experimentation Tax Credit
As you can see, there are many tax implications resulting from the fiscal cliff deal. If you have questions about how these may affect you, contact your tax professional.
Kira Bravo has been in public accounting since 2004 and focuses on tax planning, compliance, and consulting for closely held businesses, their owners and high net worth individuals.