As you now know, Congress, despite significant objections in the House, passed a deal that preserves most of the Bush-era tax cuts, extends many other lapsed tax provisions and continues to delay addressing the sequestration (spending cuts) issue. We’re happy to finally have some certainty on the tax side of the equation, as it allows us to develop and implement appropriate planning strategies for our clients. Of course, in classic Congressional fashion, the American Taxpayer Relief Act of 2012, as the bill has been termed, adds additional layers of complexity to the already byzantine Internal Revenue Code.
The following paragraphs identify a number of the main individual tax features of the act:
Alternative Minimum Tax (AMT)
The exemption amount for AMT on individuals was patched for 2012 and permanently indexed for inflation. The 2012 exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers. Without the increase to the exemption amount, an estimated additional 28 million taxpayers would have been subject to AMT.
Individual Tax Rates
All individual marginal tax rates that were part of the Bush-era tax cuts have been maintained (10%, 15%, 25%, 28%, 33% and 35%). The act introduces a new top rate of 39.6% to be imposed on taxable income over $400,000 for single filers, $425,000 for head-of-household filers and $450,000 for married taxpayers filing jointly.
Phaseout of Itemized Deductions and Personal Exemptions
The phaseouts of itemized deductions and personal exemptions are reinstated, albeit at higher levels than in the past: $250,000 for single taxpayers, $275,000 for heads of household and $300,000 for married taxpayers filing jointly. Thus the benefits of certain itemized deductions and personal exemptions will be limited if adjusted gross income exceeds the applicable threshold.
Capital Gains and Dividends
A 20% rate will apply to long-term capital gains and qualified dividends only for taxpayers above the top income tax bracket threshold, while the 15% rate is retained for taxpayers in the middle brackets. The zero percent rate is also retained for taxpayers in the 10% and 15% brackets.
Estate and Gift Tax
The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012). However, the top tax rate increases from 35% to 40%. The estate tax “portability” provision, which allows a surviving spouse to take advantage of the deceased spouse’s unused exemption amount, was made permanent.
Various temporary tax provisions previously enacted are made permanent. A sampling of these provisions includes:
- Marriage penalty relief (i.e., the increased size of the 15% rate bracket and increased standard deduction for married taxpayers filing jointly);
- The exclusion for employer-provided educational assistance;
- The enhanced rules for student loan deductions; and
- The higher contribution amount and other enhancements to Coverdell education savings accounts.
Individual Credits Expired at the End of 2012 – Extended Through 2018
The American opportunity tax credit for qualified tuition and other expenses of higher education was extended through 2018. Enhanced provisions of the child tax credit were also extended for the same five-year period.
Individual Credits Expired at the End of 2011 – Extended Through 2013
A number of temporary individual tax provisions were also extended through 2013, such as:
- Deduction for certain expenses of elementary and secondary school teachers;
- Deduction of state and local general sales taxes;
- Above-the-line deduction for qualified tuition and related expenses; and
- Tax-free distributions from individual retirement accounts for charitable purposes.
While this summary has identified a number of the provisions of the act with broader applicability, it is far from exhaustive. Many other provisions will impact individual taxpayers, and much of the bill was also designed to address expired or expiring business tax provisions. Additionally, a number of energy credits and provisions are extended through 2013 or are modified by the act. The full text of the legislation – all 157 pages – will surely be a cure for your insomnia.
The fight over spending cuts looms large over the next several months, and the uncertainty with respect to the outcome could create additional stock market volatility. But as Michael Chasnoff noted in his September 2012 Viewpoint, predicting where we’ll end up is a fool’s errand. You will be better served by tuning out the short-term focus of the financial media and adhering to a disciplined, long-term investment strategy. And as advisors, we will dedicate our time to identifying the new planning challenges and opportunities created by the numerous changes to the tax code.