To avoid the so-called fiscal cliff, Congress passed the American Taxpayer Relief Act of 2012 (ATRA) on Jan. 1. The act prevents income tax hikes for most taxpayers and averts a major expansion of the alternative minimum tax’s (AMT’s) reach. It also shrinks scheduled gift and estate tax increases and extends a variety of tax breaks for individuals and businesses. Here’s a closer look at what it may mean for your taxes.
Rates, Rates, Rates
Had ATRA not been passed, individual tax rates would have increased considerably. Fortunately, the new law keeps — for 2013 and beyond — the 2012 ordinary-income rates of 10%, 15%, 25%, 28%, 33% and 35%. The steeper 39.6% rate will permanently return, however. It will be levied on taxable income exceeding $400,000 for singles, $425,000 for heads of households and $450,000 for married couples filing jointly. (These thresholds will be indexed for inflation in future years.)
The permanence of these rates means that, for 2013, you can consider accelerating deductible expenses into the current year and deferring income to the next year, where possible. As long as you won’t be in a higher tax bracket in 2014, this traditional timing strategy can be beneficial because it allows you to defer tax.
For most tax brackets, long-term capital gains rates will permanently be 15%, with taxpayers in the bottom two brackets paying 0%. Higher-income taxpayers will, however, face the permanent return of the 20% rate. The income thresholds are the same as the ones for the 39.6% ordinary-income rate.
Qualified dividends will permanently continue to qualify for long-term capital gains treatment. But taxpayers who face the higher 20% rate on long-term capital gains generally will also face it on qualified dividends. The good news is that this is much lower than the ordinary-income rate that would have applied without ATRA.
Finally, the permanent return of limits on personal exemptions and some itemized deductions could cause the effective income tax rate you pay to increase. The limits go into effect when adjusted gross income (AGI) exceeds $250,000 (singles), $275,000 (heads of households) and $300,000 (joint filers). (The thresholds will also be indexed for inflation in the future.)
AMT Less of a Danger
The fiscal cliff threatened to drag lots of people into the alternative minimum tax (AMT) trap. The AMT is a separate tax system designed to ensure that “wealthy” taxpayers with “excessive” deductions pay some income tax. Basically, if AMT liability exceeds regular income tax liability, you must pay the AMT. And the expiration of higher AMT exemptions at the end of 2011 was one of the tax increases contributing to the fiscal cliff.
ATRA permanently — and retroactively to Jan. 1, 2012 — extends higher exemption amounts. Beginning with the 2013 tax year, these amounts will be indexed for inflation. The higher exemptions and inflation indexing reduce the likelihood that millions of middle-income taxpayers could become subject to the AMT.
Gift and Estate Taxes
Compared to what otherwise would have occurred, ATRA provides substantial relief. However, compared to 2012, it will result in an estate tax increase for some taxpayers.
Without ATRA, gift, estate and generation-skipping transfer tax exemptions would have dropped more than $4 million and the top rates would have skyrocketed from 35% to 55% beginning in 2013. ATRA permanently retains the 2012 exemptions (indexed for inflation, for a 2013 exemption of $5.25 million) and increases the top rates by five percentage points, to 40%.
Even with the rate increases, many taxpayers can be pleased with the changes. The exemptions are at an all-time-high level and will continue to increase with inflation. So even if you’ve used up your exemptions, each year you’ll have a little more available. ATRA also makes exemption portability permanent, which will make it easier for married couples to take full advantage of their exemptions. And it makes permanent certain GST tax protections as well as a break for estates of owners of closely held businesses.
Tax Breaks Extended
ATRA also revives, extends or makes permanent these individual tax breaks:
- Deduction for state and local sales tax,
- Enhanced child tax credit and child and dependent care credit,
- Several education-related breaks,
- Many energy incentives,
- Deductions for certain mortgage insurance premiums and the exclusion for certain canceled mortgage debt, and
- For taxpayers age 70½ or older, the ability to make tax-free IRA distributions to charity (up to $100,000 per year).
The new law revives for 2012 and 2013 certain breaks for businesses that had expired at the end of 2011:
- Enhanced Section 179 expensing,
- Work Opportunity tax credit,
- Transit benefit parity,
- Research tax credit, and
- 15-year straight line depreciation for qualified leasehold or retail improvements and qualified restaurant property.
ATRA also extends 50% bonus depreciation through 2013; 2014 for certain property.
Although the new tax law revived most of the popular tax provisions, it didn’t extend payroll tax relief, which means a tax hike for anyone with earned income. Also be aware that many breaks were extended only through 2013, and Congress may also look at tax reform this year. So there might be more changes in the future.