The American Taxpayer Relief Act and How It Affects You

On January 1, 2013, by a vote of 89-8, the Senate passed H.R. 8, the American Taxpayer Relief Act of 2012. Congress then passed the Act by a vote of 257-167 in order to avoid the fiscal cliff.

On January 2, President Obama signed the American Taxpayer Relief Act of 2012 (the Act) into law, preventing many of the tax increases that were slated to go into effect this year. Although the Act kept many of the tax breaks from expiring, there are a few tax increases that will affect high-income earners and those contributing to Social Security.

Both sides of the isle enjoyed success within the Act. The Democratic Party was successful in increasing tax rates on the wealthier taxpayers; while the Republican Party was successful in making the majority of the Bush-era tax cuts permanent.

Summarized below are the most significant changes affecting both individuals and businesses.

Social Security Payroll Tax Increase
The Act addressed the expiration of the temporary reduction in the Social Security payroll tax, which had been reduced for 2011 and 2012. In 2013, the payroll tax for Social Security has increased from 4.2% to 6.2%, thus workers will see their net pay decrease by 2%. The maximum amount of wages subject to Social Security tax is $113,700, making the maximum total increase $2,274.

Income Tax Rates
While the President pushed for tax increases on households earning over $250,000 and individuals with an income over $200,000, the ultimate agreement resulted in a tax increase for households earning over $450,000 and individuals with an income over $400,000.

Originally, tax rates for individuals were slated to increase to 15%, 28%, 31%, 36% and 39.6%. Instead, they remained at 10%, 15%, 25%, 28%, 33% and 35%. However, a 39.6% tax rate will be applied to those filers with income over a certain threshold: $450,000 for joint filers, $425,000 for head of household, $400,000 for single filers and $225,000 for married taxpayers filing separately.

Increase in Capital Gains and Dividend Rates
Starting in 2013, those taxpayers subject to the 39.6% tax rate will also see the maximum income tax rate on long-term capital gain and qualified dividend income increase from 15% to 20%. For lower income taxpayers, the maximum capital gains rate will stay at 15%. Note that these changes did not alter the Medicare surtax on net investment income of 3.8%. This surtax is effective as of 2013 and will affect both groups of taxpayers on income above certain thresholds.

Permanent Changes to Estate and Gift Taxes
Estate and gift taxes were a key issue for high-income earners in the debate for estate, gift and GST tax rates and lifetime exemption amounts. The lifetime gift tax exemption was set to drop to $1,000,000 and the estate tax was set to increase from 35% to 55% in 2013. However, the Act held the exemption at $5,000,000 (adjusted for inflation) and increased the maximum estate tax rate to 40%. It still allows for the exemption to remain portable between spouses.

Phase-Out of Itemized Deductions & Personal Exemptions Reinstated
Beginning in 2013, the Personal Exemption Phase-Out (PEP) and the phase-out of itemized deductions (Pease) have been reinstated, thereby reducing tax benefits for high-income households. For joint filers, the starting threshold is $300,000, $275,000 for heads of household and $250,000 for individuals.

Alternative Minimum Tax “Patch” Made Permanent
Had the Act not addressed the Alternative Minimum Tax (AMT), the exemption amounts for 2012 would have been $33,750 for individuals, $45,000 for households and $22,500 for married taxpayers filing separately. However, the Act permanently increased the exemption amounts to $50,600 for individuals, $78,750 for households and $39,375 for married persons filing separately. The exemption amounts are retroactive for tax years after 2011. For tax years after 2012, the exemption amounts are indexed for inflation.

Credit Extensions from the American Recovery and Reinvestment Tax Act of 2009
The Act also extends a few credits from the American Recovery and Reinvestment Tax Act of 2009 that were due to expire at the end of 2012. The Child Tax Credit, the American Opportunity Tax Credit and the Earned Income Tax Credit will be extended for an additional five years.

Extensions for Businesses
The Act did not just affect individuals; there were also changes for businesses. Increasingly, more and more businesses are organized as partnerships, LLCs and S-Corporations, where federal taxation is calculated at the individual level. Therefore, while the Act is largely discussed as pertaining to individual taxation, these changes also affect businesses and the income taxes they generate. In addition, favorable tax incentives, such as the following credits, were extended through 2013:

• 50% bonus depreciation extended for one year, and the maximum Section 179 expense amount was increased to $500,000 for 2012 and 2013
• Production Tax Credit (PTC), an important tax incentive for renewable energy extended through 2013
• R&D credit—which had expired at the end of 2011—is now extended through 2013
• Tax credit for businesses who hire veterans extended through 2013

Change may bring uncertainty; however, by looking forward and planning accordingly, we can help you find the best strategy to ensure your financial success. If you have any questions, please contact me at (805) 963-7811 or bforeman@bpw.com.