After weeks of negotiation between the Obama administration and Senate Republicans, it appears that a new tax package is ready to be revealed. The US Senate passed legislation (by a vote of 89 to 8) to avert the “fiscal cliff” sending the American Taxpayer Relief Act (ATRA) of 2012 to the House where it was also approved. The ATRA includes allowing the Bush-era tax cuts to expire for individuals with incomes over $400,000 and families with incomes over $450,000. The Act also permanently patches the alternative minimum tax (AMT), revives many now-expired tax extenders, and provides for a maximum estate tax of 40% with a $5 million exclusion along with other estate and gift and business provisions. The provisions and highlights of the Act are summarized below:
- Income tax rate increase beginning January 1, 2013. A top rate of 39.6% (up from 35%) will be imposed on individuals making more than $400,000 a year, $425,000 for head of household, and $450,000 for married filing joint. Individual marginal tax rates of 10, 15, 25, 28, 33, and 35% at the end of 2012, therefore, are now set going forward at the same 10, 15, 25, 28, 33, and 35% rates, but with an additional 39.6% rate carved out from the old 35% bracket range.
- 2% Social Security reduction gone. All taxpayers will 2% find less in their paycheck in 2013 because of what the ATRA did not include: the new law effectively raises taxes for all wage earners (and those self-employed) by not extending the 2012 payroll tax holiday that had reduced OASDI taxes from 6.2% to 4.2% on earned income up to the Social Security wage base $113,700 for 2013).
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Capital Gains and Dividends. The maximum capital gains tax will rise from 15% to 20% for individuals taxed at the 39.6% rates. All other taxpayers will continue to enjoy a capital gains and dividends tax at a maximum rate of 15%. A zero percent rate will also continue to apply to capital gains and dividends to the extent income falls below the top of the 15% income tax bracket–projected for 2013 to be $72,500 for joint filers and $36,250 for singles. Qualified dividends for all taxpayers continue to be taxed at capital gains rates, rather than ordinary income tax rates as prior to 2003.
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Alternative minimum tax patched. A permanent AMT patch, adjusted for inflation, will be made retroactive to 2012, promising to protect an additional 30 million taxpayers for AMT liability. This will be done by increasing the exemption amounts and allowing nonrefundable personal credits to the full amount of the individual’s regular tax and AMT.
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Pease Limitation. The Act officially revives the “Pease” limitation on itemized deductions. The Pease limitation reduces the total amount of a higher-income taxpayer’s otherwise allowable itemized deductions by 3% of the amount by which the taxpayer’s adjusted gross income exceeds an applicable threshold. Certain items, such as medical expenses, investment interest, and casualty, theft or wagering losses, are excluded.
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Personal Exemption Phaseout. Under the phaseout, the total amount of exemptions that may be claimed is reduced by 2% for each $2,500, or portion thereof, by which the taxpayer’s adjusted gross income exceeds the applicable threshold.
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Personal Tax Credits.
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Child Tax Credit. The Act extends permanently the $1,000 child tax credit.
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Earned Income Credit. The Act makes permanent or extends through 2017 enhancements to the earned income credit (EIC).
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Adoption Credit/Assistance. The Act permanently extends Bush-era enhancements to the adoption credit and the income exclusion for employer-paid or reimbursed adoption expenses up to $10,000 both for non-special needs adoptions and special needs adoptions.
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Child and Dependent Care Credit. The Act permanently extends the credit with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.
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American Opportunity Credit. The Act extends through 2017 the American Opportunity Tax Credit. The AOTC rewards qualified taxpayers with a tax credit of 100% of the first $2,000 of qualified tuition and related expenses and 25% of the next $2,000, for a total maximum credit of $2,500 per eligible student.
- Other personal deductions and exclusions.
The following deductions and exclusions are extended only through 2013:- Discharge of qualified principal residence exclusion;
- $250 above-the-line teacher deduction;
- Mortgage insurance premiums treated as residence interest;
- Deduction for state and local taxes;
- Above-the-line deduction for tuition; and
- IRA-to-charity exclusion (plus special provisions allowing transfers made in January 2013 to be treated as made in 2012).