On Jan. 2, 2013, President Barack Obama signed into law a massive tax package designed to help avert the fiscal cliff. Titled the American Taxpayer Relief Act of 2012 (H.R. 8), it makes sweeping changes to income, employment, and estate and gift taxes. These are too numerous to cover properly here, so only selected items will be explained now.
Some tax rules have been made permanent, while others are extended for one, two, or five years. Overall, the act is touted as a tax cut because the 10-year revenue effect is nearly a loss of $4 trillion. However, looking deeper into the act, many taxpayers may find they are paying more. Key changes that were (or were not) made by the act include:
The reinstatement of the 39.6 percent tax bracket on "high-income" taxpayers. These include single filers with taxable income over $400,000, heads of households with taxable income over $425,000, joint filers with taxable income over $450,000, and married persons filing separately with taxable income over $225,000.
The expiration of the payroll tax cut holiday. In 2011 and 2012, employees and self-employed individuals had their Social Security tax rate reduced by two percentage points. Thus employees paid 4.2 percent and self-employed individuals paid 10.2 percent on earnings up to the annual wage base. For 2013, employees paid 6.2 percent and self-employed individuals pay 12.2 percent on a wage base of $113,700.
Estate and gift tax rules have been made permanent, enabling taxpayers to do estate planning with certainty. The top estate tax rate is 40 percent. The exclusion amount is fixed at $5 million, adjusted annually for inflation. For estates of decedents dying in 2012 the exclusion is $5.12 million. For estates of decedents dying in 2013, the exclusion is projected to be $5.25 million. In addition, portability, which is a rule allowing the surviving spouse to add any unused exclusion amount from his/her spouse to his/her own exclusion amount, has been made permanent. Gift taxes have been permanently reunified with estate taxes, so that the top rate on taxable gifts is 40 percent and the lifetime gift tax exclusion amount is the same as the estate tax exclusion amount.
As part of the president's promise to make high-income taxpayers pay their "fair share," the top rate on capital gains and qualified dividends has been raised along with the rate on ordinary income. Most taxpayers will see no difference in the taxation of long-term capital gains and qualified dividends. Thus, taxpayers in the 10 percent or 15 percent tax bracket pay zero tax on such income. Taxpayers in the 25 percent, 28 percent, 33 percent, and 35 percent tax brackets pay 15 percent on such income. However, taxpayers in the new 39.6 percent tax bracket will pay 20 percent on such income starting in 2013 (Code Sec. 1(h)).
The 20 percent rate applies to single filers with taxable income over $400,000, heads of households with taxable income over $425,000, joint filers with taxable income over $450,000, and married persons filing separately with taxable income over $225,000.
The hike in the top tax rate on capital gains and qualified dividends does not impact the rates that apply for certain other purposes. Thus, the 25 percent rate continues to apply to certain depreciation recapture, and the 28 percent rate to collectibles gains and the non-excludable portion of gains from the sale of Sec. 1202 stock.
The act extends for two years (2012 and 2013) the opportunity for taxpayers in any tax bracket to create tax-free capital gains on the sale of small business stock. As a result of the act, the 100 percent exclusion applies to stock acquired in 2012 and 2013 as long as the stock is held for more than five years. The exclusion only applies to "qualified small business stock" (Code Sec. 1202). The corporation must have gross assets below set limits and operate within certain industries, such as technology, manufacturing, retailing, and wholesaling.
Alternative Minimum Tax
Individuals who successfully reduce their regular income taxes through exclusions and deductions may find themselves subject to the alternative minimum tax (AMT) (Code Secs. 55 through 59). The problem with the AMT was the fact that the exemption amount was not indexed annually for inflation. Thus, as tax rules for regular taxes were adjusted for inflation each year, thereby helping to cut the regular tax, an increasing number of filers found that they were subject to the AMT.
Each year, Congress had to pass a law to raise the exemption amount in order to keep approximately 25 to 30 million taxpayers from owing this tax. Many had advocated that this tax be eliminated entirely, but the cost of doing so was too great. Instead, Congress adopted indexing for the AMT exemption amount. Even so, the Joint Committee on Taxation estimates that the 10-year revenue effect will be a loss of $1.815 trillion.
This change eliminates uncertainty for individuals and enables them to do tax planning with the AMT in mind.
As a result of the act, the exemption amounts for 2012 (and 2013) are: