The American Taxpayer Relief Act of 2012 (ARTA) was signed into law by President Obama on January 2, 2013, averting some of the large tax increases that would otherwise have been effective this year. This article provides a summary of some of the key provisions of this law.
Personal Income Taxes
Income tax brackets- The income tax brackets from the Bush tax cuts are permanently retained for taxable income under $400,000 for individuals and under $450,000 for couples. Taxable income above these levels is taxed at 39.6%. These brackets will be annually adjusted for inflation.
Payroll taxes- The employee portion of the Social Security tax had been reduced from 6.2% to 4.2% for 2011 and 2012 but this two year old cut to payroll taxes was not extended.
Capital gains and qualified dividends taxes- The tax on long term capital gains and qualified dividends will be 20% for taxpayers with income over $400,000 for individuals and $450,000 for couples. For lower income levels, the tax will be 0 percent or 15 percent. These tax rates are permanent. Short term capital gains will continue to be taxed as ordinary income.
Itemized deductions and personal exemptions- itemized deductions and personal exemptions will be limited for adjusted gross income over $250,000 for individuals and over $300,000 for couples. The calculations are complex but the experts believe that these phase outs will effectively increase marginal tax rates for affected taxpayers by 1%.
Alternative Minimum Tax (AMT)- The AMT exemption has been made permanent and will be adjusted for inflation annually to prevent it from impacting middle class families.
Deductions for Sales Taxes- the itemized deduction for state and local sales taxes in lieu of state and local income taxes is extended through 2013.
Qualified Charitable Distributions from an IRA to a Charity- In 2013, people over 70.5 years of age can continue to contribute up to $100,000 directly from their IRAs to a charity without the distribution being treated as taxable income by the IRS. Additionally, these distributions made by February 1, 2013 can be counted for the 2012 tax year. Thus, a qualified charitable distribution up to $100,000 will count toward the satisfaction of Required Minimum Distributions from the IRA.
Discharged mortgage debt- In 2013, income from the forgiveness of mortgage debt of up to $2 million on a primary residence can be excluded from taxes.
Coverdell Education Savings Accounts- The $2,000 maximum contribution amount and treatment of elementary and secondary school expenses as well as college expenses as qualified expenditures are permanently extended.
Other Education Incentives- the American Opportunity Tax Credit has been extended through 2017. The above the line deduction for qualified tuition and related expenses has also been extended until December 31, 2013 and it has been retroactively re-instated to 2012. Individuals with modified adjusted gross income below $55,000 and couples with modified adjusted gross income below $110,000 can continue to deduct up to $2,500 of student loan interest per year. Finally, the law also makes permanent the exclusion for up to $5,250 for employer-provided education assistance for college and graduate school education.
Estate and Gift taxes
Tax rates and exemption amounts- The law now provides for a permanent gift and estate tax exemption amount of $5 million. The exemption amount will be annually adjusted for inflation. The federal estate and gift tax rate above this exemption level is also made permanent at 40%.
Portability- The law makes permanent the portability of the estate tax exemption. At 2012 levels, this means that the second spouse to die could pass on as much as $10.24 million before federal estate taxes become effective.
State Death Tax Deduction- the law now provides for a federal estate tax deduction for state estate, inheritance, legacy or succession taxes.
Income Tax Effects of the Health Care and Education Reconciliation Act of 2010 (HCERA)
Beginning in 2013, workers will pay an additional 0.9% Medicare tax on their wages and self-employment income over $200,000 for individuals and over $250,000 for couples. Consequently, the employee’s share of the Medicare payroll tax levied on earned income above these thresholds will increase from 1.45% to 2.35%.
Beginning in 2013, high income households will start paying a 3.8% Medicare surtax on at least a portion of their investment income such as realized capital gains, dividends, interest, rents and royalties etc. The surtax will apply to the lesser of net investment income or the amount by which modified adjusted gross income exceeds $200,000 for individuals or $250,000 for couples.
While the above notes highlight some of the important changes in the law, there are others of which you should be aware. You should review with your tax professional how these changes might impact you personally.