AMERICAN TAXPAYER RELIEF ACT OF 2012

On January 3, 2013, as President Obama promised, he signed into law The American Taxpayer Relief Act of 2012, effectively avoiding the draconian provisions of a Fiscal Cliff that would have caused approximately 98 percent of all working Americans and 97 percent of small businesses to pay a much higher tax on earned and unearned income.

This Bill retroactively extends the tax breaks of 2012 and permanently patched the Alternative Minimum Tax that will be now pegged to inflation. How this bill will affect your tax return and what to expect in the coming months, I will share with you as more information unfolds. For now, let me explain the changes that will affect us for 2013 and beyond.

President Obama averted a steep incline on income tax rates for middle-income families permanently. For the first time in 20 years, wealthy taxpayers will face an increase in their tax and the rates will be immediate and permanent. For individuals earning more than $400,000 and families with incomes over $450,000, the Bush-Era Tax Cuts finally sunset on them after 2012. However, if your income is below those amounts, you have nothing to worry about because the Bush Tax Cuts were also made permanent to keep them low. Although these rates are now “permanent”, nothing would stop Congress from reconsidering the entire tax rate structure in the future as part of an overall tax reform when they do convene again to discuss spending cuts or sequestration. Unfortunately, the payroll tax holiday was not extended and if you are an active employee or self-employed, your Social Security taxes will increase by 2 percentage points up to the Social Security wage base of $113,700 for 2013. This means your take home pay will be further reduced.

For individuals earning over $400,000 ($450,000 if married filing joint), the tax rate increases to 39.6 percent and a maximum capital gain rate of 20 percent on capital gains and dividends.

Personal Income Tax Rates

As long as your earned and earned income remains below the above thresholds, you will not be tax at the higher rate of 39.6 percent. Thus, if you file single and your income for 2013 is greater than $400,000, or if you file head of household and your income is more than $425,000, or greater than $450,000 if MFJ, then you will be taxed at the 39.6 percent rate.

The individual marginal tax rates are as follows:

For Single Taxpayers

For Couples Filing Jointly

Note:Taxpayers who find themselves within the 39.6 percent marginal income tax bracket nevertheless also benefit from the extension of all Bush Tax rates below that level.

Comment: President Obama had originally proposed to peg the increased tax rates to the taxpayer’s adjusted gross income (AGI). The new American Taxpayer Relief Act of 2012 not only raised the dollar value but also simplified the proposal by keying the new higher threshold amount to the taxpayer’s taxable income. That is; after all above the line deductions and adjustments for the standard or itemized deductions and exemption subtractions are factored out, the remainder is the taxable income.

CREDITS, DEDUCTIONS & TAXES EXTENDED

The Child Tax Credit (CTC): Would you believe that without the Act of 2012, this credit would have fallen from $1,000 to $500 per qualifying child? The Act of 2102 avoided this Bush Era sunset and now extends permanently the $1,000 child tax credit.

Note: The CTC is available for children under the age of 17 at the close of 2012.

The Child and Dependent Care Credit (CDCC): The Act of 2012 extends permanently the Bush enhancements. The current 35 percent credit rate is made permanent with the $3,000 cap on qualifying expenses for one child and $6,000 for two or more individuals.

The American Opportunity Tax Credit (AOTC): The Act of 2012 extends through 2017 the AOTC. A qualifying taxpayer can receive a full 100 percent credit of the first $2,500 paid for qualified tuition and related expenses, and 25 percent of the next $2,000 for a total credit of $2,500 for an eligible student. The credit is also available for the first four years of post secondary education.

The Adoption Credit/Assistance: The Act of 2012 extends permanently the Bush enhancements and assistance to the adoption credit for an employer paid or reimbursed expenses up to $10,000, indexed for inflation, as an exclusion from income both for non-special needs and special needs children. The phase out limit starts at $189,710 for 2012.

Employer Provided Child Care Credit: The Act of 2012 permanently extends the Bush Era credit for employer provided Child Care facilities and services.

Qualified Tuition & Related Expenses Deduction: The Act of 2012 also extends until December 31, 2012, the first $4,000 in deductions for taxpayers whose modified adjusted gross income, MAGI, won’t exceed $65,000 if filing single, or head of household, or $130,000 if filing married filing joint or qualifying widow. Taxpayers with MAGI of $65,000 but not over $80,000 ($160,000 for MFJ) are allowed a maximum deduction of up to $2,000.

Note: A taxpayer cannot claim both the AOTC and the qualified Tuition Credit in the same year either for themselves or for the same student.

Student Loan Interest Deduction: The Act of 2012 permanently suspends the 60-month rule for the $2,500 above the line student loan interest deduction. It also expands the MAGI range for phaseout of the deduction permanently and repeals the restriction that makes voluntary payments of interest non-deductible permanently.

Federal Scholarships: The Act of 2012 makes permanent the exclusion from income for National Health Service Corps Scholarship Program and the Armed Forces Scholarship Program.

Retirement Savings: The Act of 2012 opened up a very important planning opportunity for taxpayers. In general, if you participated in a 401(k) or similar plan, the plan allowed you to roll over funds into a designated Roth IRA account in the same plan subject to certain qualifying events and age limits. The Act lifts most of these restrictions and now allows participants in 401(k) plans with in-plan Roth conversion features making the transfer much more simpler. Keep in mind, any rollover of this type triggers a taxable event. Congress instituted this change as a means to raise revenue to help with the deficit.

State and Local Tax Deduction: The Act of 2012 extends through 2013 the option to claim an itemized deduction for state and local general sales tax in lieu of state and local income taxes. You would want to take a deduction for the greater of the two. However, if you live in a state that has no state and local income taxes you can elect to claim this deduction.

Alternative Minimum Tax (AMT): The Act of 2012 patched the AMT tax (higher tax) for 2012 and subsequent years by increasing the exemption amounts and allowed non-refundable credits to the full amount of an individual’s regular tax. The Act provides for an annual inflation adjustment to the exemption amounts for years beyond 2012. The exemption amounts for 2012 are:

• $50,600 for single and head of household;

• $78,750 for MFJ and QW; and

• $36,375 for MFS

For 2013, the projected amounts are:

• $51,900 for single and head of household;

• $80,750 for MFJ and QW; and

• $40,575 for MFS

Because of this change, over 60 million Americans will not be subjected to this dreaded tax apart from the regular tax, thus avoiding the draconian provisions under the Bush Era taxes.

Itemized Deductions: The Pease Limitation, named after a member of Congress who sponsored the original provision, and was eliminated by the EGTRRA as extended by the 2010 Tax Relief Act was again revived under the Act of 2012. This Act essentially reduces the total amount of deductions for higher income taxpayers by three percent of the amount by which his AGI exceeds the applicable threshold. The rule does not affect deductions such as medical expense, investment interest expenses, casualty loss, theft and gambling losses.

The higher applicable thresholds are:

• $300,000 for MFJ and QW

• $275,000 for heads of households

• $250,000 for single filers, and

• $150,000 for MFS

The Marriage Penalty Relief: Without the Act of 2012, the standard deduction for MFJ would be 167 percent of the deduction for a single filer rather that 200 percent (a loss of 33 percent in deductions). For MFJ in 2013, that would have meant a drop from $12,200 to $10,150, a loss of $2,050 in deductions.

Capital Gains and Dividends: Taxpayers with less than $400,000/ $450,000 if MFJ won’t be affected. If income exceeds these levels then the top tax rate would be 20 percent, increased from 15 percent in 2011. This top tax rate will apply to the extent income exceeds the thresholds set for the 39.6 percent rate which are $400,000 and $450,000 for families. For taxpayers whose incomes are below these levels the top tax rate is 15 percent. If incomes fall further below the 15 percent rate then none of the incomes will be subject to the capital gains and dividends tax rates.

Estate and Gift Taxes: The Act of 2012 avoided a new higher 55 percent estate tax on individuals and entities and replaced it with a new 40 percent rate with an annually inflation adjusted $5 million exclusion for estates of decedents dying after December 31, 2012. This means if the value of the decedent’s estate falls below the $5 million exclusion amount, there is no estate tax.

For tax year 2012, the 2010 Tax Relief Act lowered the 55 percent rate to 35 percent with an exclusion of $5.12 million, indexed for inflation. This part of legislation would only affect about 1-2 percent of all American taxpayers.

Portability: The Act of 2012 makes permanent “portability” (transfer) of any unused exclusionary amounts from a deceased spouse to his/her surviving spouse. This feature of estate tax law was made available only to estates of decedents dying after December 31, 2010 and before January 1, 2013. The surviving spouse can now apply any unused exclusion of the deceased spouse (DSUE) to be applied against any transfers made by the surviving spouse during life and at death.

State Death Tax Credit/Deduction: The Act of 2012 also extends the deduction for state estate taxes.

Gift Taxes: The Act of 2012 provides a 40 percent tax rate and unifies the estate and gift tax exemption of $5 million, adjusted for inflation for gifts made after 2012.

Generation Skipping Tax (GST): The Act of 2012 provides for a 40 percent GST tax rate with a $5 million exemption and extends a number of GST related provisions that were scheduled to expire after 2012.

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If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.