On January 1, 2013, the Senate passed H.R. 8, the American Taxpayer Relief Act (the “Act”), by a vote of 89 to 8. Later in the day, the House of Representatives also passed the bill by a vote of 257 to 167. President Obama signed the bill into law yesterday. The Act, which is retroactive to January 1, 2013, prevents many tax-related consequences of the “Fiscal Cliff,” but will increase income taxes for higher income individuals and increase payroll taxes for every individual who earns wages. All of the tax rate changes in the Act are permanent.
The Act includes the following provisions:
Increase in Income Tax Rate for High Income Individuals. For tax years beginning in 2013, the income tax rates for individuals will stay at 10%, 15%, 25%, 28%, 33% and 35% (instead of moving to 15%, 28%, 31%, 36% and 39.6% as would have occurred in the absence of legislation), but with a 39.6% rate applying for income above the threshold of $450,000 for joint filers, $425,000 for head of household filers and $400,000 for single filers.
Increase in Capital Gain and Dividend Rates for High Income Individuals. For tax years beginning in 2013, the top rate for capital gains and dividends will rise to 20% for taxpayers with incomes exceeding $450,000 for joint filers, $425,000 for head of household filers and $400,000 for single filers. When combined with the 3.8% surtax on investment-type income pursuant to Code Section 1411, the overall capital gains rate for higher-income taxpayers beginning in 2013 will be 23.8%. For tax years beginning in 2013, taxpayers who are generally subject to an income tax rate of below 25% on their ordinary income will be taxed on capital gains and dividends at the rate of 0%. Taxpayers subject to an income tax rate of 25% or above on their ordinary income who do not fall within the high income category will continue to be subject to the 15% rate on capital gains and dividends.
Exemption and Deduction Phase-Out for High Income Individuals. For tax years beginning in 2013, the exemption and deduction phase-outs for high income individuals (the so-called PEP and Pease limitations respectively), are reinstated. These phase-outs apply to those with income starting at $300,000 for joint filers and a surviving spouse, $275,000 for heads of household and $250,000 for single filers. Like the rate change provisions, these changes are permanent.
Alternative Minimum Tax Relief Made Permanent. On a permanent basis, the Act increases the exemption amount for determining alternative minimum taxable income and indexes the amount for inflation. The Act also permits for the first time, retroactive to the 2012 taxable year, the use of nonrefundable personal tax credits to offet the taxpayer’s entire AMT liability.
Increase in Federal Estate, Gift and Generation-Skipping Tax. For tax years beginning in 2013, the Act keeps the exemption level for these taxes at $5,120,000, indexed for inflation, but increases the top tax rate from 35% to 40%. Without these changes, the law would have reverted to a $1,000,000 exemption amount and a 55% top rate.
Increase in Payroll Taxes. The Act did not extend the 2% reduction in the Social Security portion of the FICA tax collected from wages, which had lowered the rate to 4.2% from 6.2% for 2011 and 2012. As a result, a worker who earns $113,700 (the 2013 Social Security tax ceiling) will see a $2,274 increase in FICA taxes in 2013.
Extension of Certain Individual Tax Breaks. The Act extends various individual tax breaks for a limited time, including the deduction for certain expenses of elementary and secondary school teachers, the exclusion for the discharge of indebtedness with respect to a qualified principal residence, the treatment of mortgage insurance premiums as qualified residence interest, the option to deduct state and local sales taxes, and the above-the-line deduction for qualified tuition and related expenses.
Extension of Certain Business Tax Breaks. The Act extends for a limited time (generally two years) various business credits, exemptions and deductions, including the Section 41 research credit, the Section 45A Indian employment tax credit, the Section 45D new markets tax credit, the Section 51 work opportunity tax credit and the exclusion of gain on the disposition of certain small business stock.
Hear from a panel of experienced tax professionals – Dorsey partners Mary Streitz, Kim Severson and Bill Berens, along with John Kelly of UnitedHealth Group Incorporated and Bruce Shnider of the University of Minnesota Law School – as they present the key details regarding the Act and illustrate the impact of the changes on a group of hypothetical taxpayers. They also will provide an update regarding the expected showdown to come in Congress in early 2013 on the two remaining aspects of the Fiscal Cliff – the automatic spending cuts and breach of the debt ceiling limit – as well as the prospects for broader tax reform. Please join our panel of experts on Tuesday, January 22, at 12 noon Central Time for an interesting and informative session on these matters. Stay tuned for additional details on registration.
IRS CIRCULAR 230 NOTICE: Any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.