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An Overview of The American Taxpayer Relief Act of 2012

President Obama, using the autopen, signed the American Taxpayer Relief Act of 2012 (the “Act”) into law on January 2, 2013. The following is a summary list of the Act’s major changes to and extensions of prior law. We will keep you informed of possible important updates resulting from a comprehensive tax reform.

Individual Income Tax Rates. The Act keeps in place the Bush-era income tax rates for most individuals (staying at 10%, 15%, 25%, 28%, 33%, and 35%) except that the highest marginal income tax bracket rises to 39.6% for individual filers whose taxable income is more than $400,000 ($450,000 for joint filers and for qualifying surviving spouses; $425,000 for qualifying heads of households; and $225,000 for married taxpayers filing separately).

Medicare Taxes. The Act does not affect the Medicare taxes effective in 2013. There will thus be an additional 0.9% Medicare tax on wages over $200,000 for single individual filers ($250,000 for joint filers and qualifying surviving spouses; $200,000 for qualifying heads of households; and $125,000 for married taxpayers filing separately). The 3.8% Medicare tax on certain net investment income also starts to apply to single individual filers with modified adjusted gross income over $200,000 ($250,000 for joint filers and for qualifying surviving spouses; $200,000 for qualifying heads of households; and $125,000 for married taxpayers filing separately).

Capital Gain and Dividends. The Act increases the long-term capital gain rate from 15% to 20% for single individual filers with taxable income above $400,000 ($450,000 for joint filers and for qualifying surviving spouses; $425,000 for qualifying heads of households; and $225,000 for married taxpayers filing separately). Dividends are also generally taxed at the same rate as capital gains. The aforementioned 3.8% Medicare tax is effective in 2013, resulting in a 23.8% overall capital gain tax rate for affected higher-income taxpayers.

Permanent Alternative Minimum Tax (“AMT”) Relief. The Act provides permanent AMT relief beginning in 2012 and going forward. The AMT is the tax imposed on an individual, estate, or trust in an amount by which the tentative minimum tax exceeds the regular income tax for the taxable year.

Personal Exemption Phaseout (“PEP”). PEP, which had previously been suspended, returns in 2013 for certain taxpayers. Thus, for taxable years beginning in 2013, the personal exemption phases out for single individual filers with an Adjusted Gross Income amount of $250,000 ($300,000 for joint filers and qualifying surviving spouses; $275,000 for qualifying heads of households; and $150,000 for married taxpayers filing separately). The PEP starting threshold amounts are indexed for inflation.

Pease Limitation. The Act reinstates the Pease Limitation (which reduces the value of itemized deductions) with a starting threshold of $250,000 for single individual taxpayers ($300,000 for joint filers and qualifying surviving spouses; $275,000 for qualifying heads of households; and $150,000 for married individuals filing separately). The Pease Limitation threshold amounts are indexed for inflation.

Payroll Tax. The Act does not extend the payroll tax cut that previously reduced the employee portion of Social Security taxes from 6.2% to 4.2%. As such, beginning in 2013, both the employee and the employer share of these taxes is at 6.2%.

Estate, Gift, and Generation-Skipping Transfer Taxes. The Act sets the maximum federal estate tax rate at 40% (previously 35%) with an inflation-adjusted exemption amount of $5 million ($10 million per married couple) in cumulative taxable transfers from the gift or the estate tax. In 2012, the exemption was equal to $5,120,000; the exemption amount is now $5,250,000. As such, those taxpayers who have already utilized their full exemption amount have another $130,000 this year. Moreover, the annual gift tax exclusion amount is now $14,000 (previously $13,000) per donor and per donee.

The Act also allows portability between spouses, which generally makes it possible for a surviving spouse to apply a decedent’s unused exemption to the surviving spouse’s own transfers during life and death. Finally, for 2013, the generation-skipping transfer tax is imposed at a flat rate of 40% on generation-skipping transfers in excess of $5,250,000. Please further note that the Act does not affect the estate planning techniques (e.g., Grantor Retained Annuity Trusts, Qualified Personal Residence Trusts) we described in our September 7, 2012 ; as such, these estate planning techniques remain effective wealth transfer strategies for certain taxpayers with assets that have a high potential for appreciation.

 

Tax Extensions. The following items are some of the tax provisions that the Act extends (and in some cases modifies) through 2013:

  • Bonus depreciation;
  • Section 179 small business expensing;
  • Deduction of State and local general sales taxes;
  • Above-the-line deduction for qualified tuition and related expenses;
  • Research Credit;
  • Employer Wage Credit for employees who are active duty members of the uniformed services;
  • Child Tax Credit;
  • Work Opportunity Tax Credit;
  • New Markets Tax Credit;
  • Earned Income Tax Credit;
  • Indian Employment Tax Credit;
  • Railroad Track Maintenance Credit;
  • Tax-free distributions from individual retirement plans to qualifying charities;
  • Temporary exclusion of gain on the sale of certain small business stock;
  • Reduction of recognition period for built-in gains tax in the case of S corporations;
  • Tax incentives for empowerment zones;
  • Subpart F exception for active financing income;
  • Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules.

 

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