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January 2013 Tip of the Month (2 of 2)

THE 2012 TAX ACT (THAT WAS FINALLY PASSED IN 2013)

Yesterday President Obama signed into law the legislation that enacted a last-minute budget deal (we noted on weather.com it was 73 degrees in Hawaii where he signed it while it’s but 31 degrees here in Mount Laurel, New Jersey as we digest and write this).  While it took a year-long impasse in Congress to take some action, at least it averted income tax increases for most Americans. 

Anyway, here is what we at Abo and Company believe our clients would like to know most about the tax angles evident in The American Taxpayer Relief Act of 2012. These are necessarily just brief bullet points of changes of that we think are most likely to affect you, your business, and your investments from the law (and gives us one more opportunity to wish you and yours our best for a prosperous 2013).

  1. All the previous individual tax rates are kept at 10%, 15%, 25%, 28%, 33% and 35% with a new top rate added of 39.6%. This new top rate applies to taxable income over $400,000 for single filers, $425,000 for head of household filers and $450,000 for joint filers ($225,000 if you file married-filing-separately). The thresholds for the top rate will be indexed for inflation.

  1. You didn’t think it was that straight forward, did you? A “hidden” tax increase Congress put in this act are provisions we had in past years that phase-out a taxpayer’s exemptions and certain itemized deductions.  These “phase outs” affect single taxpayers with income over $250,000; over $275,000 for heads of household; and over $300,000 for married taxpayers filing jointly. These two provisions reduce tax benefits for high-income earners by phasing out exemptions and itemized deductions. We estimate this increases the TRUE EFFECTIVE tax rate on taxable income by approximately 1%. 

  1. The Alternative Minimum Tax (AMT) patch has been "permanently fixed" for the 2012 tax year and for each year thereafter.  The exemption amounts for AMT, permanently indexed for inflation, are $78,750 for joint filers in 2012 and $50,600 for single filers in 2012.     

  1. The tax rate on long-term capital gains and qualified dividends for individuals above the top income tax bracket threshold will increase from 15% to at 20% effective 1/1/2013.  Such applies to those with incomes above $450,000 (joint) or $400,000 (single). The 15% rate is retained for taxpayers in the middle brackets while the zero rate is also preserved for those in the 10% and 15% brackets. What’s going on? Well, considering the 3.8% Medicare tax on Net Investment Income also going into effect January 1, 2013, the top federal tax rate on long-term capital gains will now be 23.8% on the "rich" (whatever that means).  At least it remains at 15% for in the middle-class (again, we think this term is subject to interpretation).   

  1. The estate and gift tax exclusion amount has been saved and will stay at $5 million but will be indexed for inflation ($5.12 million for 2012). However, the top estate tax rate increases from 35% to 40% effective 1/1/2013.  Our estate planning colleagues at the Estate and Financial Planning Council of Southern New Jersey (Abo is a past president) and the Society of Financial Service Professionals–South Jersey Chapter (Abo is currently an officer) are especially pleased that  we can also tell our clients that the estate tax “portability” election was made permanent by this new law.  Here, if an election is made, a surviving spouse’s estate tax exemption is effectively increased by his/her deceased spouse’s unused exemption amount.

  1. We were all “up in the air” but the law extended many provisions effecting our clients we feared would end, including:
  • Marriage penalty relief (permanent);
  • The liberalize            d child and dependent care rules (permanent);
  • The employer provided child care credit (permanent);
  • The exclusion for employer provided educational assistance (permanent);
  • The enhanced rules for student loan deductions (permanent);
  • The American Opportunity Tax Credit for qualified tuition and other expenses of higher education (through 2018)
  • Enhanced provisions of the child tax credit (through 2018);
  • Earned income tax credit (through 2018);
  • The Research & Development tax credit (through 2013)
  • Deduction for qualified expenses of elementary and secondary school teachers (through 2013);
  • Tax-free distributions from IRAs for charitable contribution purposes (through 2013);  
  • Exclusion from gross income of qualified indebtedness of a principal residence (through 2013);
  • Premiums for mortgage insurance treated as qualified residence interest (through 2013);
  • Above-the-line deduction for qualified tuition and related expenses (though 2013);
  • The 15-year accelerated recovery period for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (through 2013);
  • The $500,000 per year expensing deduction under Section 179 for certain fixed assets (through 2013)
  • The 50% first year bonus depreciation (through 2013);
  • Reduction to the shorter 5-year period (as opposed to 10 years) for the application of the S Corporation Built-In gains tax (through 2013);
  • The non-business energy credit for a lifetime max of $500 and $200 for windows/skylights (through 2013).
  1. Notably NOT extended was the 2% payroll tax cut on the employee portion of Social Security taxes. If you’ve already received a paycheck in 2013, you should have seen your individual (i.e. non-employer) share of Social Security increased from 4.2% to 6.2%.

We should remind you that, due to previous legislation, the following tax changes are now effective:

  1. The new 0.9% health insurance tax on earned income over $250,000 ($200,000 for those filing as single).  This totally borne by the employee and not matched by the employer as with the regular Social Security or Medicare tax.

  1. As mentioned earlier, starting 1/1/2013 there is a new 3.8% Medicare Contribution Tax imposed on the lesser of net investment income or Modified Adjusted Gross Income in excess of $200,000 for a single taxpayer; $250,000 for a taxpayer filing jointly or a surviving spouse; and $125,000 for a married taxpayer filing separately. This new surtax also applies to estates and trusts. Such unearned income includes non-business capital gains, rents, royalties, interest income, and dividend income. Taxable gains from the sale of one’s personal residence (i.e. the gains in excess of the normal exclusions) are also considered part of the Net Investment Income computation as are Passive activities.   

Phew! You now have the skinny on but some of the key tax provisions included in the new law. As you can see, the changes are not so simple.

Stay tuned because there are more changes coming.  There will undoubtedly be confusion and we can only hope for further clarification as we all work through it. Until then, cheers!