The American Taxpayer Relief Act of 2012
In the wake of the media hype surrounding the fabled “fiscal cliff”, Congress and the President have passed the American Taxpayer Relief Act of 2012 (the “Act”). To assist you in understanding the implications of the Act, the following is a brief yet comprehensive summary of the landscape for federal income, estate, and gift taxes beginning January 1, 2013.
For single taxpayers with taxable income in excess of $400,000 and for joint filers with taxable income in excess of $450,000, the maximum tax rates for qualified dividends and capital gains will now be 20% (factoring in the 3.8% Medicare tax attributable to Section 1411, the effective rate will be 23.8%) instead of 15%. The maximum tax rate for all other taxpayers remains at 15%; moreover, a zero-percent rate will continue to apply to qualified capital gains and dividends to the extent income falls below the top of the 15% tax bracket.
A 39.6% rate will apply to joint filers with taxable income in excess of $450,000 and for single taxpayers with taxable income in excess of $400,000 (up from 35% in 2012). Otherwise, the Act preserves all of the tax rates from 2012.
The Act did not affect the 3.8% Medicare tax which went into effect January 1, 2013. Thus, for single taxpayers with taxable income in excess of $200,000 and for joint filers with taxable income in excess of $250,000, the 3.8% Medicare tax applies to interest, dividends and other investment income as well as income from trades or businesses in which the taxpayer is a passive investor. For example, if a single taxpayer had $150,000 of W-2 income and $125,000 of net investment income, the tax would be assessed against $75,000 which is the excess of the $275,000 AGI over the $200,000 threshold amount for single taxpayers, and would result in an additional $2,850 tax liability.
The Act results in a permanent increase in the Alternative Minimum Tax (“AMT”) exemption amounts. The AMT exemption amount for the 2013 taxable year is $80,800, less 25% of AMTI exceeding $153,900(zero exemption when AMTI is $477,100) for joint filers and surviving spouses, and $51,900, less 25% of AMTI exceeding $115,400 (zero exemption when AMTI is $323,000) for single taxpayers. For all periods following the 2012 taxable year, the AMT exemption amounts will be indexed for inflation.
The Act sets the estate and gift tax exemption amount permanently at $5,000,000 per person, adjusted annually for inflation for all periods following the 2011 taxable year. Current inflation data suggests an estate and gift tax exemption amount equal to $5,250,000 for the 2013 taxable year. The Act continues the reunification of the gift tax and estate tax established in 2010 but increases the maximum gift tax rate and estate tax rate from 35% to 40%.The Act results in a permanent ability of estates to elect to transfer any of the decedent’s unused exemption amount to the surviving spouse, which unused exemption amount can then be applied against any tax liability of the surviving spouse attributable to subsequent inter-vivos gifts and testamentary transfers.
The Act extended certain tax benefits including (i) the exclusion of cancellation of indebtedness income resulting from discharged qualified principal residence indebtedness; (ii) treatment of mortgage insurance premiums as deductible qualified residence interest; (iii) two (2) year extension of ability to elect to deduct state and local sales and use taxes instead of state and local income taxes; (iv) non-taxable IRA transfers to eligible charities; (v) two (2) year extension of above-the-line deduction for qualified tuition and related expenses for higher education; and (vi) the $1,000 child tax credit.
Due to the expiration of the 2% payroll tax cut, the Social Security withholding tax rate on wages earned by employees has increased from 4.2% to 6.2%. For single taxpayers earning wages in excess of $200,000 and joint filers earning wages in excess of $250,000, the Medicare surtax withheld from wages has increased by 0.9% (from 1.45% to 2.35%).
Due to the exigencies of the circumstances and the fact that most of the changes were rate-driven, the Act does not contain much ambiguity. Thus, the Act itself does little to create new opportunities for creative tax planning. However, the new and separate 3.8% Medicare tax might present some planning opportunities.