As the nation grazed the edge of the fiscal cliff, legislation was passed that, among other things, permanently extends the reduced Bush-era income tax rates for lower and middle income taxpayers, allows the top rates on earned income and investment income to rise for wealthier households, permanently “patches” the individual alternative minimum tax, and increases the estate and gift tax rate for high-value estates.
Below is a brief summary of the American Taxpayer Relief Act of 2012.
Income Tax Rates:
The top income tax bracket rises to 39.6% (from 35%) for individuals with taxable income in excess of $400.000 and for married couples in excess of $450,000. For those who make less than those thresholds, the American Taxpayer Relief Act of 2012 permanently extends the Bush-era tax rates (10%, 15%, 25%, 28%, 33%, and 35%).
Capital Gains and Dividends:
The top income tax bracket for capital gains and dividends rises to 20% (from 15% in 2012) for individuals with taxable income in excess of $400,000 and for married couples in excess of $450,000. * For those individuals at the lower income levels, the top tax rate on these investment earnings remains at 15 percent. Those in the 10 and 15 percent brackets would owe no capital gains taxes.
*This new tax bracket is in addition to the 3.8% Obamacare tax on passive income for taxpayers who have taxable income over $250,000 so that the new top rate will be 23.8% on passive income.
Alternative Minimum Tax:
The Act solves (at least in theory) the Alternative Minimum Tax (AMT) problem by permanently indexing the AMT exemption amounts for inflation. The AMT is an alternative method of calculating tax, which was created to effectively create a minimum tax for some taxpayers. Prior to the Act, Congress was required to patch the tax every year to reflect changes in inflation. The AMT exemption amount for 2012 is $50,600 for individuals and $78,750 for married couples.
A phase out of itemized deductions applies for 2013 for individuals who have an adjusted gross income of $250,000, and married couples with an adjusted gross income of $300,000.
Estate, Generation Skipping and Gift Taxes:
The Act makes permanent the $5 million exemption amounts (indexed for inflation) for the estate tax, the gift tax, and the generation-skipping transfer tax–the same exemptions that were in effect for 2011 and 2012. The top tax rate, however, is increased to 40% (up from 35%) beginning in 2013.
The Act also permanently extends the “portability” provision in effect for 2011 and 2012 that allows the executor of a deceased individual’s estate to transfer any unused exemption amount to the individual’s surviving spouse.
Every American will see less money in his or her paycheck in 2013. The cut to employee’s portions of the Social Security Payroll Tax expired on January 1, 2013 and was not addressed by the American Taxpayer Relief Act of 2012. Payroll taxes were allowed to increase from 4.2% to 6.2% and high income individuals will also be subject to a new 0.9% Medicare tax on earned income.
Section 179 Expensing:
The increased Section 179 deduction limits applicable to small business will be extended through 2013. Section 179 permits business to deduct the full purchase price of qualifying equipment and/or software purchased or financed during a tax year instead of depreciating such qualifying equipment and/or software over a period of years.
Individual Tax Extenders:
Various individual tax cuts will be extended, including deductions for state and local sales taxes, qualified tuition expenses, and mortgage insurance premiums. The Child Tax Credit and the Earned Income Tax Credit have also been extended through 2017.
Business Tax Extenders:
In addition to section 179 expensing, various business tax cuts will be extended, including the research and work opportunity credits.
This brief overview of some important considerations associated with the American Taxpayer Relief Act of 2012 is by no means comprehensive. Always seek the advice of a competent professional when making important legal decisions.