The Impact of the American Taxpayer Relief Act of 2012 On Individuals
During the last few months of 2012, one could not avoid the drama unfolding in Congress concerning the “fiscal cliff.” Just when falling off the fiscal cliff appeared to be a certainty, Congress passed the American Taxpayer Relief Act (the “Act”) of 2012 on January 1, 2013. Set forth below is a summary of some of the important changes made by the Act.
Had Congress not acted, individual tax rates were slated to increase to 15, 28, 31, 36 and 39.6 percent. The Act preserves and makes permanent the lower Bush-era rate structure, except for single individuals with taxable income over $400,000, married couples (filing a joint return) with taxable income over $450,000, and heads of household with taxable income over $425,000. Income above these amounts will be taxed at the top 39.6 rate. However, taxpayers who find themselves in the 39.6 marginal bracket will still benefit from the lower marginal rates for all income below these levels. The threshold amounts for the highest marginal rate will be indexed for inflation after 2013.
Long Term Capital Gains Rates
Absent the Act, the maximum tax rate for capital gains and qualified dividends was scheduled to jump to 20 percent from 15 percent. The Act reinstates the Bush-era capital gains rates for all individuals except higher-income taxpayers. For individuals with taxable income below the threshold, the 15 percent capital gains rate will continue to apply except to taxpayers in the 15 percent tax bracket, who will continue to enjoy the zero percent capital gains tax rate. It should be noted that installment payments received after 2012 are subject to the tax rates for the year the payment is received, and not the year of the sale. Thus the 20 percent rate will apply to installment payments received in 2013 and later years by higher-income taxpayers.
Alternative Minimum Tax
The Alternative Minimum Tax (“AMT”), enacted by the Tax Reform Act of 1969, is essentially a parallel tax system designed to prevent ultra-high income taxpayers from reducing their tax liabilities to zero. However, since the AMT exemption was not indexed for inflation, the taxpayers who ultimately have been most affected by the AMT are middle income earners with large itemized deductions for taxes and home equity loan interest. The Act permanently increases the AMT exemption amounts to $50,600 for single taxpayers and $78,750 for married taxpayers filing jointly. The Act also provides for an annual inflation adjustment to the exemption amounts for years after 2013.
Itemized Deductions/Personal Exemption Phase Out
Not all provisions of the Act were beneficial to taxpayers. The Act revives the limitation on itemized deductions and personal exemption phase out after 2012 for higher-income individuals. The new thresholds for both the itemized deduction limitation and the personal exemption phase out are $300,000 for married couples and $250,000 for single taxpayers. These thresholds will be indexed for inflation after 2013.
Estate, Gift, and Generation-skipping Transfer Taxes
The estate tax provision of the Act, which had appeared to be a deal breaker, provides for a permanent maximum estate tax rate of 45 percent, and a $5 million estate, gift and generation-skipping transfer tax exclusion for tax years after 2012. The exclusion will be indexed for inflation for years after 2013. The Act also makes permanent “portability” of the exemption between spouses.
There are several existing tax provisions that were not affected by the Act, but are mentioned here due to their significant impact on taxpayers in 2013 and subsequent years.
End of Payroll Tax Holiday
During 2011 and 2012, an individual’s share of FICA tax was reduced by 2%, resulting in more take home pay for every wage earner and self-employed individual. This reduction was slated to expire at the end of 2012 and was not reinstated. What this means is that an individual earning $75,000 will take home $1,500 less in 2013 than in 2012, and an individual who reaches the FICA “limit” (increased from $110,100 to $113,700) will take home $2,274 less.
Tax on Investment Income
Starting in 2013, under the Patient Protection and Affordable Care Act of 2010, higher income taxpayers are subject to a 3.8 percent additional tax on “net investment income.” Net investment income includes income from interest, dividends, annuities, royalties, rents, and dispositions of property unless the income is attributable to a trade or business. The thresholds for this tax are $200,000 for single taxpayers and $250,000 for married persons filing joint returns. Taxpayers whose income exceeds these amounts must pay the additional 3.8 percent tax on capital gains, whether short-term or long-term. Thus the effective top rate for net capital gains for the “higher-income” taxpayers will be 23.8 percent for long-term gain and 43.4 percent for short-term capital gains.
The American Taxpayer Relief Act was intended to bring some certainty to the tax code, a volume consisting of more than four million words. It must be noted that, although Congress has made a number of the tax law changes “permanent,” nothing, of course, precludes them from reconsidering the entire tax rate structure in the future as part of a comprehensive tax reform.