On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (the "Act"), which provides that tax rates increase on the nation's highest earners, while also extending dozens of tax cuts for individuals and businesses.

Executive Summary:

  • Raises the top income tax rate to 39.6% for married couples earning $450,000 or more (single taxpayers earning $400,000 or more). Those amounts are indexed for inflation.
  • Raises long-term capital gains and qualifying dividends tax rate from 15% to 20% for taxpayers in the 39.6% tax bracket for regular and alternative minimum tax.
  • Permanently extends Bush-era tax cuts from 2001 and 2003 for all other taxpayers.
  • Reinstates phase-out of personal exemptions and overall limitation on itemized deductions for married couples filing jointly earning over $300,000 (single taxpayers earning over $250,000).
  • Raises the maximum estate and gift tax rate from 35% to 40%.
  • Keeps the exemption equivalent amount for estate, gift and GST taxes at $5 Million, adjusted for inflation ($5,250,000 for 2013).
  • Patches the AMT for 2012 and adjusts the exemption amount for inflation going forward.
  • In 2010, the employee portion of Social Security was reduced to 4.2% - the "Payroll Tax Holiday". Under the Act, the Payroll Tax Holiday terminated and the employee portion of Social Security reverted to 6.2%. 

The following provides a broader review of certain provisions of the Act:

I. Marginal Individual Income Tax Rates for 2013

For single taxpayers with income over $400,000 in 2013, the highest marginal rate is permanently increased to 39.6%. The Act imposes a stiff marriage penalty - married couples filing jointly with combined incomes of $450,000 are subject to the 39.6% rate. For low and moderate income taxpayers, the Act retains the existing rate structure.

The Act does not use the $400,000 ($450,000 for married taxpayers filing jointly) thresholds for all purposes. Specifically, the phase-outs for itemized deductions and personal exemptions apply at adjusted gross incomes of $250,000 for individuals and $300,000 for joint returns. Also, the Pease limitation on itemized deductions is reinstated, reducing most itemized deductions by 3% of the amount by which adjusted gross income exceeds a specified threshold, up to a maximum reduction of 80% of itemized deductions. The thresholds are indexed for inflation beginning in 2014.

II. Permanent Alternative Minimum Tax Relief for 2012 and Future Years

The alternative minimum tax (the "AMT") is frequently referred to as the "shadow income tax." While the AMT's original purpose was to assure that high net worth individuals paid a minimum amount of federal income tax; over the years, the AMT has increasingly affected the middle class. If a taxpayer's AMT liability exceeds his or her regular income tax liability, the taxpayer pays the higher AMT tax liability. The AMT does not "kick-in" until a taxpayer earns income over a certain yearly threshold amount. Thus, any increase in the AMT threshold results in fewer households being subject to the tax. To prevent an expansion of the number of households subject to the AMT, the ACT increases the threshold amount from $33,750 to $50,600 (and from $45,000 to $78,750 for joint returns) in 2012 and indexes the threshold amount, the threshold exemption phase-out, and income bracket beginning in 2013. In addition, if certain tax credits reduce a taxpayer's AMT liability below zero, such excess credits may now be carried forward to future years.

III. Dividends and Capital Gains

The federal income tax rate on long-term capital gains has been increased from 15% to 20% for single taxpayers with incomes of $400,000 or more ($450,000 or more for married couples filing jointly) beginning in 2013. Further, capital gains can also be subject to a 3.8% Medicare Tax beginning in 2013.

Qualified dividends remain taxable at the rates applicable to long-term capital gains. Thus, qualified dividends of single taxpayers with income of at least $400,000 ($450,000 for married couples) are taxed at the 20% rate. Further, dividend income can also be subject to the 3.8% Medicare Tax beginning in 2013.

IV. Estate, Gift and GST Taxes

The Act also includes changes to the Federal Estate, Gift and GST Taxes. Specifically:

  1. The marginal Federal estate, gift and GST tax rates go up to 40% from 35%.
  2. The exemption equivalent amount for estate, gift and GST tax purposes remains at $5 Million, indexed for inflation ($5,250,000 in 2013).
  3. In 2013, the applicable exclusion amount for estate and gift tax purposes is $14,000 per donor, per donee.
  4. State death taxes will continue to be deductible under I.R.C. 2058 in calculating the federal taxable estate.
  5. Portability of the estate and gift tax "exemption equivalent amount" is continued so that a surviving spouse may inherit the unused gift and estate tax "exemption equivalent amount" of his or her last predeceased spouse. The GST ("exemption equivalent amount"), however, is not portable.
  6. The changes are made "permanent" by eliminating the sunset provisions contained in the 2001 and 2010 Tax Acts, thereby extending the additional tax relief contained in prior legislation.

 

Noticeably absent is any legislation falling under the category of estate, gift and GST tax "loophole" closers. Given the concessions made by the Obama Administration on the amount of the "exemption equivalent amount" and the top marginal rate, the measures set forth in the President's Budget Proposal may still be under consideration, including the following:

  1. Changes to the requirements for qualified grantor retained annuity trusts extending the minimum term to 10 years, prohibiting a zeroed out remainder value and providing for a maximum term of 10 years beyond the life expectancy of the grantor.
  2. Restrictions in the ability to use valuation discounts in connection with transfers of interests in family owned entities.
  3. Changes to the grantor trust rules that would inhibit the effectiveness of a variety of estate planning transactions.
  4. A limitation on the period that a trust would remain exempt from GST tax.

 

The possibility that any of the foregoing provisions would be enacted as revenue raisers weighs in favor of lifetime planning.

V. Retirement Funds and Individual Retirement Accounts

The Act extends, until December 31, 2013, the ability of individuals who have attained age 701/2 to transfer up to $100,000 per year directly from an IRA to certain public charities without including the amount transferred in their gross income. The Act also permits IRA distributions in January of 2013 to be treated as having been made in 2012 for these purposes and permits taxpayers who received distributions in December of 2012 to treat the portion of that distribution that is transferred in cash to a public charity before February 1, 2013, as if it had been transferred directly from the IRA to the charity for these purposes.

The Act also permits Section 401(k) and other qualified plans, Section 403(b) plans and Section 457(b) plans that permit Roth contributions to allow participants to elect to have the plan transfer to Roth accounts under the plan amounts that otherwise would not be distributable under the plan (for example, because of the limitations generally applicable to Section 401(k) or other elective deferrals). Participants would be subject to immediate tax on the amounts transferred. This provision is effective for transfers after December 31, 2012.

As always, we encourage you to seek advice on how these changes affect you and your family.

We would be pleased to respond to your questions and concerns