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Major Provisions of the American Taxpayer Relief Act of 2012

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On January 2, 2013 President Obama signed into law the American Taxpayer Relief Act of 2012.  While the new law increases the top marginal income tax rate for individuals earning up to $400,000 (up to $450,000 for joint filers) to 39.6%, it allowed the United States to avoid going over the so called “fiscal cliff” which would have required across-the-board increases to all tax brackets and mandatory spending cuts.

The Effects on the Individual Taxpayer

While the bill, which represents the largest tax increase in twenty years, targeted the wealthiest 2% of Americans, it will lead to more than 75% of American households seeing a tax increase from their 2012 tax levels. All employees, regardless of their income level, will see a 2% jump in the employee portion of the social security tax.  In 2013, the first $113,700 of an employee’s wages will be subject to a 6.2% employee contribution to the social security fund as opposed to 4.2% in 2012.  A recent article in The Wall Street Journal estimated the average annual tax increase for people making $50,000-$75,000 will be $822, $100,000-200,000 the increase will average $1,784 and for those earning between $200,000 and $500,000 the increase will be $2,711.

The wealthiest taxpayers, in addition to having their top tax bracket increase to 39.6%, will be subject to additional tax increases which could increase their effective tax rate well above the 39.6% level.  Taxpayers in the top bracket will see their long-term capital gain rate and qualified dividend rate increase from 15% to 20% effective January 1, 2013.  In addition, married taxpayers with adjusted gross income in excess of $300,000 (individuals above $250,000) will be subject to a limitation on the amount of itemized deductions they can claim.  This is a complex calculation but could cause the highest income taxpayer’s to eliminate up to 80% of their itemized deductions.

This provision applies to all itemized deductions including charitable contributions and mortgage interest.  Married taxpayers with adjusted gross income in excess of $300,000 (individuals above $250,000) will also be subject to a phase out of their personal exemptions.  In 2012, these taxpayers received a $3,800 per exemption deduction in computing their regular tax liability.

The Health Care Surtax

As a result of the 2010 health care legislation beginning in 2013, married taxpayers whose modified adjusted gross income exceed $250,000 and single taxpayers whose modified adjusted gross income exceed $200,000 will be subject, in addition to their income tax liability, to a surtax equal to the lesser of 3.8% of their net investment income (“NII”) for the tax year, or the excess, if any, of the taxpayer’s modified adjusted gross income over the threshold amount ($250,000 for joint taxpayers, $200,000 for single taxpayers).  When taking into account the increased tax rate added by the American Taxpayer Relief Act of 2012 with the NII surtax, taxpayers in 2013 could be subject to a combined income and NII surtax rate of as much as 43.4% on investment income such as interest, rent and passive investments as well as combined rate of 23.8% on long term capital gains and qualified dividend income.

Changes to The Estate Tax

With regards to the estate tax, the bill made permanent the current $5,000,000 exemption, indexed for inflation ($5,120,000 in 2012), but did increase the top tax rate from 35% to 40%.  If Congress had failed to reach agreement, the unified credit equivalent exemption had been scheduled to return to $1,000,000 and the top tax rate to 55%.  In addition, the bill has made permanent the unification of the estate and gift tax rates as the American Taxpayer Relief Act provides for a 40% tax rate and a unified estate and gift tax exemption of $5,000,000 (inflation adjusted) for gifts made after 2012.

In addition, the bill makes permanent portability between spouses, which allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent’s unused exclusion to the surviving spouse’s own transfers during life and at death.

Business Provisions

While most of the bill focused on increasing the tax paid by the wealthiest individuals, there were a few taxpayer friendly provisions with regards to businesses.  These provisions included the extension of the 50% bonus depreciation rules for qualifying assets placed in service during 2013, extension of increased Section 179 limitation ($500,000) for small businesses and the extension of the research and development credit.

Our Future Outlook

We do not feel that we have seen the last of changes in income tax laws for 2013. It is projected that in February of 2013 it will be necessary for the U.S. Treasury to request that Congress increase the federal borrowing limit. On March 1, 2013 deep cuts in military and other domestic programs are scheduled to take effect unless Congress can agree on other tax increases and spending cuts to decrease the federal deficit. In addition, by March 27, 2013 Congress must approve funding for the government budget for the remainder of the fiscal year which ends on September 30, 2013.

There has been much discussion among members of Congress that the best way to deal with these issues and go forward is to overhaul the current Internal Revenue Code and adopt comprehensive tax reform. During the recent negotiations President Obama expressed an openness to embark on both corporate tax reform aimed at improving international competitiveness and individual taxes to simplify the code. It is our intention to keep you updated and informed about these changes, if, and when they occur.

Above we have briefly discussed some of the major provisions of the American Taxpayer Relief Act of 2012.  We invite you to read more details in the attached American Taxpayer Relief Act of 2012 Special Report by CCH, one of our firm’s outside resource services. If you would like to discuss how the Act may affect your personal tax situation please do not hesitate to contact us.