On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (“the 2012 Tax Act”), which affects all taxpayers. The summary below highlights some of the more relevant tax provisions in the 2012 Tax Act:
Payroll Tax Holiday
The payroll tax holiday, which reduced the employee portion of social security taxes by 2% (from 6.2% to 4.2%) has not been extended, which means your employee paychecks will be 2% lower on up to $113,700 of wages (the maximum subject to social security tax) in 2013.
For individuals with taxable income exceeding $400,000 ($450,000 for married filing joint (“MFJ”)):
- The portion of taxable income exceeding this threshold is now subject to a 39.6% tax rate instead of a 35% rate.
- The tax rate on some or all of your qualified dividends and long-term capital gains (“LTCG”) will increase from 15% to 20%.
- The lower 15% rate will still apply to the extent your taxable income (excluding LTCG and qualified dividends) is less than the threshold amount ($400k, or $450k for MFJ).
- Assume you are MFJ and have the following income:
LTCG and qualified dividends $100k
Other taxable income $500k
Taxable income (excluding LTCG and qualified dividends) is $500k, which is more than the threshold for MFJ ($450k). Thus, none of your LTCG or qualified dividends will qualify for the 15% reduced rate.
- Now assume you are MFJ with the following income:
LTCG and qualified dividends $100k
Other taxable income $410k
In this case, you would pay a 15% tax on $40k (threshold of $450k less $410k) of the $100k LTCG and qualified dividends and 20% on the remaining $60k.
- When taking into account the 3.8% Medicare surtax on net investment income (which applies to taxpayers with modified AGI exceeding $200,000 ($250,000 if MFJ)), the maximum rate of 20% effectively rises to 23.8%.
Pease Limitation on Itemized Deductions
The Pease limitation on certain itemized deductions has been restored for certain taxpayers with adjusted gross income (“AGI”) over $250,000 ($300,000 for MFJ).
- The limitation reduces total deductible state taxes, property taxes, mortgage interest, charitable donations, and 2% miscellaneous expenses by 3% of the amount by which your AGI exceeds the threshold.
- It does not apply to medical expenses, investment interest, and casualty or theft losses.
- The Pease limitation does not apply to taxpayers in AMT, so the deductions allowed for AMT purposes (mortgage interest and charitable donations) are not limited.
Personal Exemption Phase-out
The personal exemption phase-out (“PEP”) has also been restored for taxpayers with adjusted gross income (“AGI”) over $250,000 ($300,000 for MFJ).
IRA Transfers to Charities
The 2012 Act renewed the ability of individuals age 70 1/2 or older to directly transfer up to $100,000 per year, tax-free, from an IRA to a qualified charity.
- The provision applies retroactively from January 1, 2012 through December 31, 2013.
- Such distributions are excluded from gross income and do not qualify for a charitable deduction (and are thus not subject to the charitable contribution percentage limits).
401(k) to Roth 401(k) Conversions
- The new legislation allows you to convert any portion of your employer-sponsored 401(k) plan to a Roth account under the plan (an “in-plan Roth conversion”), provided your plan offers a designated Roth account and also permits the in-plan conversion. Employer-sponsored plans are not required by law to offer such features, so if you are interested in doing an in-plan Roth conversion, please check with your employer regarding the terms of your plan.
- Prior to the 2012 Tax Act, only participants who were eligible for a distribution under the plan (either because they had reached age 59 1/2 or had separated from service) could make such conversions.
- Before you do an in-plan Roth conversion, please consider the following:
- An in-plan Roth conversion will result in taxable income equal to the amount you convert. Make sure you have available funds outside of the plan to pay any taxes due.
- The tax-free distribution of earnings is only available if the designated Roth account (or “Roth 401(k)”) has been in existence for at least five years and you are at least age 59 1/2 at the time of the distribution.
- Unlike Roth IRAs, you are generally required to take minimum distributions from Roth 401(k) accounts once you reach age 70 1/2. However, the amounts in a designated Roth account can be rolled over to a Roth IRA.
- An in-plan Roth conversion cannot be undone. This is a notable difference from the IRA conversions to a Roth IRA, which can be undone by the due date of the tax return for the year of the conversion.
Other Notable Extended Provisions for Individuals
- Permanent extension of the AMT “patch”, which increases the AMT exemption each year to provide relief to millions of taxpayers
- Exclusion of 100% of the eligible gain on disposition of qualified small business stock (QSBS) acquired after September 27, 2010 and before January 1, 2014, and held for more than five years (California has recently decided that its QSBS exclusion is invalid and thus no longer conforms.)
- Exclusion from income on the discharge of up to $2 million of debt on a qualified principal residence
- Credit for energy-saving improvements made by individuals to their principal residence, with a maximum lifetime credit of $500
Depreciation Provisions for Businesses
- The enhanced Section 179 deduction, available for both new and used assets, has been extended. The maximum deduction remains at $500,000 and begins to phase out when total assets placed in service during the year exceeds $2 million.
- 50% bonus depreciation, available only on new assets, has also been extended.
Estate, Gift, and GST Taxes
- The maximum tax rate, which was scheduled to increase to 55% in 2013, has been set at 40% for taxable gifts made on or after January 1, 2013.
- The lifetime exclusion for estate and gift taxes, which was scheduled to revert to $1 million, remains at $5 million, indexed annually for inflation.
- The ability to transfer the unused portion of a decedent’s lifetime exclusion to the surviving spouse has been extended permanently.
Please contact us if you have any questions or concerns about how you may be impacted, or to discuss tax planning strategies that reflect the changes enacted by the 2012 Tax Act.
PDF print version: American Taxpayer Relief Act of 2012
Any tax advice in this communication is not intended or written by Navolio & Tallman LLP to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer, or (ii) promoting, marketing, or recommending to another party any matters addressed herein. With this newsletter, Navolio & Tallman LLP is not rendering any specific advice to the reader.