Category: Tax

2012 Taxpayer Relief Act Summary

The 2012 Taxpayer Relief Act prevents many of the tax hikes that were scheduled to go into effect this year and retain many favorable tax breaks that were scheduled to expire. However, it also increases income taxes for some high-income individuals and slightly increases transfer tax rates.

Highlights of the 2012 Taxpayer Relief Act include:

Elimination of EGTRRA Sunsetting

The 2012 Taxpayer Relief Act eliminates the sunsetting provisions in the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. The provisions in EGTRRA, other than those made permanent or extended by subsequent legislation, were set to sunset and no longer apply to tax or limitation years beginning after 2010. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the EGTRRA provisions for two additional years. Thus, under pre-2012 Taxpayer Relief Act law, beginning in 2013, the EGTRRA sunset would have wiped out a host of favorable tax rules, such as: favorable income tax rate structure for individuals; marriage penalty relief; and liberal education-related deduction rules. The 2012 Taxpayer Relief Act amends EGTRRA so that its provisions are made permanent and no longer automatically sunset in future years.

For tax years beginning after 2012, the income tax rates for most individuals will stay at 10%, 15%, 25%, 28%, 33% and 35%. However, a 39.6% rate applying for income above a certain threshold (specifically, income in excess of the “applicable threshold” over the dollar amount at which the 35% bracket begins). The applicable threshold is $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. These dollar amounts are inflation-adjusted for tax years after 2013.

Capital gain and dividend rates rise for higher-income taxpayers

For tax years beginning after 2012, the top rate for capital gains and dividends will permanently rise to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When accounting for the 3.8% surtax on investment-type income and gains for tax years beginning after 2012, the overall rate for higher-income taxpayers will be 23.8%.

For taxpayers whose ordinary income is generally taxed at a rate below 25%, capital gains and dividends will permanently be subject to a 0% rate. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends. The rate will be 18.8% for those subject to the 3.8% surtax (i.e, those with modified adjusted gross income (MAGI) over $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).

PEP limitations to apply to “high-earners”

For tax years beginning after 2012, the Personal Exemption Phaseout (PEP) was reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000(one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 by which the taxpayer’s AGI exceeds the applicable threshold. These dollar amounts are inflation-adjusted for tax years after 2013.

Pease limitations to apply to “high-earners”

For tax years beginning after 2012, the “Pease” limitation on itemized deductions, which had previously been suspended, is reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer’s adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013.

Permanent AMT relief

The 2012 Taxpayer Relief Act provides permanent alternative minimum tax (AMT) relief. The AMT is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%.

Prior to the 2012 Taxpayer Relief Act, the individual AMT exemption amounts for 2012 were to have been $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for married persons filing separately. Retroactively effective for tax years beginning after 2011, the 2012 Taxpayer Relief Act permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, it indexes these exemption amounts for inflation.

Prior to the 2012 Taxpayer Relief Act, for 2012, nonrefundable personal credits — other than the adoption credit, the child credit, the savers’ credit, the residential energy efficient property credit, the non-depreciable property portions of the alternative motor vehicle credit, the qualified plug-in electric vehicle credit, and the new qualified plug-in electric drive motor vehicle credit — would have been allowed only to the extent that the individual’s regular income tax liability exceeded his tentative minimum tax, determined without regard to the minimum tax foreign tax credit. Retroactively effective for tax years beginning after 2011, the 2012 Taxpayer Relief Act permanently allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits.

Transfer tax provisions kept intact with slight rate increase

The 2012 Taxpayer Relief Act prevents steep increases in estate, gift and generation-skipping transfer (GST) tax that were slated to occur for individuals dying and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation). However, the 2012 Taxpayer Relief Act also permanently increases the top estate, gift and rate from 35% to 40%. The 2012 Taxpayer Relief Act also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion to the surviving spouse. All changes are effective for individuals dying and gifts made after 2012.

Recovery Act extenders

The 2012 Taxpayer Relief Act extends for five years the following items that were originally enacted as part of the American Recovery and Investment Tax Act of 2009 and that were slated to expired at the end of 2012:

• The American Opportunity tax credit, which permits eligible taxpayers to claim a credit equal to 100% of the first $2,000 of qualified tuition and related expenses, and 25% of the next $2,000 of qualified tuition and related expenses (for a maximum tax credit of $2,500 for the first four years of post-secondary education);
• Eased rules for qualifying for the refundable child credit; and
• Various earned income tax credit (EITC)
  changes relating to higher EITC amounts for eligible taxpayers with three or more children, and increases in threshold phaseout amounts for singles, surviving spouses, and heads of households.

Individual extenders

The 2012 Taxpayer Relief Act extends the following items for the period indicated beyond their prior termination date as shown in the listing:

• The deduction for certain expenses of elementary and secondary school teachers, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The exclusion for discharge of qualified principal residence indebtedness, which applied for discharges before Jan. 1, 2013 and which is now continued to apply for discharges before Jan. 1, 2014;
• Parity for the exclusions for employer-provided mass transit and parking benefits, which applied before 2012 and which is now revived for 2012 and continued through 2013;
• The treatment of mortgage insurance premiums as qualified residence interest, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The option to deduct State and local general sales taxes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013.
• The special rule for contributions of capital gain real property made for conservation purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The above-the-line deduction for qualified tuition and related expenses, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013; and
• Tax-free distributions from individual retirement plans for charitable purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013. Because 2012 has already passed, a special rule permits distributions taken in 2012 to be transferred to charities for a limited period in 2013. Another special rule permits certain distributions made in 2013 as being deemed made on Dec. 31,2012.

Depreciation provisions modified and extended

The following depreciation provisions are retroactively extended by the 2012 Taxpayer Relief Act through 2014:

• 15-year straight line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements;
• 7-year recovery period for motorsports entertainment complexes;
• accelerated depreciation for business property on an Indian reservation;
• increased expensing limitations and treatment of certain real property as Code Sec. 17 property;
• special expensing rules for certain film and television productions; and
• the election to expense mine safety equipment.

The 2012 Taxpayer Relief Act also extends and modifies the 50% bonus depreciation provisions for one year so that it applies to qualified property placed in service before 2014 (before Jan. 1, 2015 for certain aircraft and long-production-period property).

Business tax breaks extended

The following business credits and special rules are also extended:

• The research credit is modified and retroactively extended for two years through 2013.
• The temporary minimum low-income tax credit rate for non-federally subsidized new buildings is extended to apply to housing credit dollar amount allocations made before Jan. 1, 2014.
• The housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds is extended two years.
• The Indian employment tax credit is retroactively extended for two years through 2013.
• The new markets tax credits is retroactively extended for two years through 2013.
• The railroad track maintenance credit is retroactively extended for two years through 2013.
• The mine rescue team training credit is retroactively extended for two years through 2013.
• The employer wage credit for employees who are active duty members of the uniformed services is retroactively extended for two years through 2013.
• The work opportunity tax credit is retroactively extended for two years through 2013.
• Qualified zone academy bonds are retroactively extended for two years through 2013.
• The enhanced charitable deduction for contributions of food inventory is retroactively extended for two years through 2013.
• Allowance of the domestic production activities deduction for activities in Puerto Rico, for the first eight tax years of the taxpayer beginning after 2005, and before 2014.
• The exclusion from a tax-exempt organization’s unrelated business taxable income (UBTI) of interest, rent, royalties, and annuities paid to it from a controlled entity is extended through 2013.
• The treatment of certain dividends of regulated investment companies (RICs) as “interest-related dividends” is extended through 2013.
• The inclusion of RICs in the definition of a “qualified investment entity” is extended through 2013.
• The exception under subpart F for active financing income (i.e., certain income from the active conduct of a banking, financing, insurance, or similar business) for tax years of a foreign corporation beginning after ’98, and before 2014, for tax years of foreign corporations beginning after 2005, and 2014.
• Look-through treatment for payments between related controlled foreign corporations (CFCs) under the foreign personal holding company rules is extended through 2013.
• The exclusion of 100% of gain on certain small business stock acquired before 2014.
• The basis adjustment to stock of S corporations making charitable contributions of property is extended to apply to tax years beginning in 2013.
• The reduction in S corporation recognition period for built-in gains tax is extended through 2013, with a 5-year period instead of a 10-year period.
• Various empowerment zone tax incentives are extended, including the designation of an empowerment zone and of additional empowerment zones (through 2013) and the period for which the percentage exclusion for qualified small business stock of a corporation which is a qualified business entity is 60% (through 2018).
• Tax-exempt financing for the New York Liberty Zone is extended for bonds issued before 2014.
• The temporary increase in the limit on cover over run excise taxes to Puerto Rico and the Virgin Islands is extended for spirits brought into the U.S. before 2014.
• The American Samoa economic development credit, as modified, is extended through 2014.

Energy-related tax breaks extended

Various energy credits are extended. These include:

• The non-business energy property credit for energy-efficient existing homes is retroactively extended for two years through 2013. A taxpayer can claim a 10% credit on the cost of: (1) qualified energy efficiency improvements, and (2) residential energy property expenditures, with a lifetime credit limit of $500 ($200 for windows and skylights).
• The alternative fuel vehicle refueling property credit is retroactively extended for two years through 2013 so that taxpayers can claim a 30% credit for qualified alternative fuel vehicle refueling property placed in service through 2013, subject to the $30,000 and $1,000 thresholds.
• The credit for 2- or 3-wheeled plug-in electric vehicles is modified and retroactively extended for two years through 2013.
• The cellulosic biofuel producer credit is modified and extended one year through 2013.
• The credit for biodiesel and renewable diesel is retroactively extended for two years through 2013.
• The production credit for Indian coal facilities placed in service before 2009 is extended one year. The credit applied to coal produced by the taxpayer at an Indian coal production facility during the 8-year period beginning on Jan. 1, 2006, and sold by the taxpayer to an unrelated person during such 8-year period and the tax year.
• The credits with respect to facilities producing energy from certain renewable resources is modified and extended one year. A facility using wind to produce electricity will be a qualified facility if it is placed in service before 2014.
• The credit for energy-efficient new homes is retroactively extended for two years through 2013.
• The credit for energy-efficient appliances is retroactively extended for two years through 2013.
• The additional depreciation deduction allowance for cellulosic biofuel plant property is modified and extended one year.
• The special rule for sales or dispositions to implement Federal Energy Regulatory Commission (FERC) or State electric restructuring policy for qualified electric utilities is retroactively extended for two years through 2013.
• The alternative fuels excise tax credits for sales or use of alternative fuels or alternative fuel mixtures is retroactively extended for two years through 2013.

Pension provision

For transfers after Dec. 31, 2012, in tax years ending after that date, plan provisions in an applicable retirement plan (which includes a qualified Roth contribution program) can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution.

If you have questions or need more information, please call us. We would be happy to talk with you at any time.

Information from Thomson Reuters/RIA was used for this summary.

2012 Year-End Tax Planning Checklists for Business Owners

• If your business is incorporated, consider taking money out of the business by way of a stock redemption if you are in the position to do so. The buy-back of the stock may yield long-term capital gain or a dividend, depending on a variety of factors. But either way, you’ll be taxed at a maximum rate of only 15% if you act this year. If you wait until next year to make your move, your long-term gains or dividends may be taxed at a higher rate if reform plans are instituted or the Bush-era tax cuts expire. And if your adjusted gross income (as specially modified) exceeds certain limits ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for all others), gains taken next year (along with other types of unearned income, such as dividends and interest) will be exposed to an extra 3.8% tax (the so-called “unearned income Medicare contribution tax”). Keep in mind that you will need expert help to plan and execute an effective pre-2013 corporate distribution.

• If you are thinking of adding to payroll, consider hiring a qualifying veteran before year-end to qualify for a work opportunity tax credit (WOTC). Under current law, the WOTC for qualifying veterans won’t be available for post-2012 hires. The WOTC for hiring veterans ranges from $2,400 to $9,600, depending on a variety of factors (such as the veteran’s period of unemployment and whether he or she has a service-connected disability).

• Put new business equipment and machinery in service before year-end to qualify for the 50% bonus first-year depreciation allowance. Unless Congress acts, this bonus depreciation allowance generally won’t be available for property placed in service after 2012. (Certain specialized assets may, however, be placed in service in 2013.)

• Make expenses qualifying for the business property expensing option. The maximum amount you can expense for a tax year beginning in 2012 is $139,000 of the cost of qualifying property placed in service for that tax year. The $139,000 amount is reduced by the amount by which the cost of qualifying property placed in service during 2012 exceeds $560,000 (the investment ceiling). For tax years beginning in 2013, unless Congress makes a change, the expensing limit will be $25,000 and the investment ceiling will be $200,000. Thus, if you anticipate needing property in early 2013, you may want to push the purchase into 2012 to gain a higher expensing deduction (if you are otherwise eligible to claim it). The time of purchase doesn’t affect the amount of the expensing deduction. You can purchase property late in the year and still get a full expensing deduction. Thus, property acquired and placed in service in the last days of 2012, rather than at the beginning of 2013, can result in a full expense deduction for 2012.

• If you are in the market for a business car, and your taste runs to large, heavy SUVs (those built on a truck chassis and rated at more than 6,000 pounds gross (loaded) vehicle weight), consider buying in 2012. Due to a combination of favorable depreciation and expensing rules, you may be able to write off most of the cost of the heavy SUV this year. Next year, the writeoff rules may not be as generous.

• Set up a self-employed retirement plan if you are self-employed and haven’t done so yet.

• Increase your basis in a partnership or S corporation if doing so will enable you to deduct a loss from it for this year. A partner’s share of partnership losses is deductible only to the extent of his partnership basis as of the end of the partnership year in which the loss occurs. An S corporation shareholder can deduct his pro rata share of an S corporation’s losses only to the extent of the total of his basis in (a) his S corporation stock, and (b) debt owed to him by the S corporation.

If you have questions, please call us. We can help you determine the best option for you.

2012 Year-End Tax Planning Checklists for Individuals

• Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. Keep in mind that beginning next year, the maximum contribution to a health FSA will be $2,500. And don’t forget that you can no longer set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.

• If you become eligible to make health savings account (HSA) contributions late this year, you can make a full year’s worth of deductible HSA contributions even if you were not eligible to make HSA contributions for the entire year. This opportunity applies even if you first became eligible in December. In brief, if you qualify for an HSA, contributions to the account are deductible (within IRS-prescribed limits), earnings on the account are tax-deferred, and distributions are tax free if made for qualifying medical expenses.

• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It would be advisable for us to meet to discuss year-end trades you should consider making.

• If you are thinking of selling assets that are likely to yield large gains, such as inherited, valuable stock, or a vacation home in a desirable resort area, try to make the sale before year-end, with due regard for market conditions. This year, long-term capital gains are taxed at a maximum rate of 15%, but the rate could be higher next year as noted above. And if your adjusted gross income (as specially modified) exceeds certain limits ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for all others), gains taken next year (along with other types of unearned income, such as dividends and interest) will be exposed to an extra 3.8% tax (the so-called “unearned income Medicare contribution tax”).

• If you are in the process of selling your main home, and expect your long-term gain from selling it to substantially exceed the $250,000 home-sale exclusion amount ($500,000 for joint filers), try to close before the end of the year (again, with due regard to market conditions). This can save capital gains taxes if rates go up and can save the 3.8% tax for those exposed to it.

• You may own appreciated-in-value stock and you want to lock in a 15% tax rate on the gain, but you think the stock still has plenty of room to grow. In this situation, consider selling the stock and then repurchasing it. You’ll pay a maximum tax of 15% on long-term gain from the stock you sell. You also will wind up with a higher basis (cost, for tax purposes) in the repurchased stock. If capital gain rates go up after 2012 and you sell the repurchased stock down the road at a profit, the total tax on the 2012 sale and the future sale could be lower than if you had not sold in 2012 and had just made a single sale in the future. This move definitely will reduce your tax bill after 2012 if you are subject to the extra 3.8% tax on unearned income.

• Consider making contributions to Roth IRAs instead of traditional IRAs. Roth IRA payouts are tax-free and thus immune from the threat of higher tax rates, as long as they are made (1) after a five-year period, and (2) on or attaining age 59, after death or disability, or for a first-time home purchase.

• If you believe a Roth IRA is better than a traditional IRA, consider converting traditional IRAs to Roth IRAs this year to avoid a possible hike in tax rates next year. Also, although a 2013 conversion won’t be hit by the 3.8% tax on unearned income, it could trigger that tax on your non-IRA gains, interest, and dividends. Reason: the taxable conversion may bring your modified adjusted gross income (AGI) above the relevant dollar threshold (e.g., $250,000 for joint filers). But conversions should be approached with caution because they will increase your AGI for 2012. And if you made a traditional IRA to Roth IRA conversion in 2010, and you chose to pay half the tax on the conversion in 2011 and the other half in 2012, making another conversion this year could expose you to a much higher tax bracket.

• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70. Failure to take a required withdrawal can result in a penalty equal to 50% of the amount of the RMD not withdrawn. If you turn age 70 this year, you can delay the first required distribution to 2013, but if you do, you will have to take a double distribution in 2013 –t he amount required for 2012 plus the amount required for 2013. Think twice before delaying 2012 distributions to 2013.  Bunching income into 2013 might push you into a higher tax bracket or bring you above the modified AGI level that will trigger a 3.8% extra tax on unearned income such as dividends, interest, and capital gains. However, it could be beneficial to take both distributions in 2013 if you will be in a substantially lower bracket in 2013, for example, because you plan to retire late this year or early the next.

• This year, unreimbursed medical expenses are deductible to the extent they exceed 7.5% of your AGI, but in 2013, for individuals under age 65, these expenses will be deductible only to the extent they exceed 10% of AGI. If you have a shot at exceeding the 7.5% floor this year, accelerate into this year “discretionary” medical expenses you were planning on making next year. Examples: prescription sunglasses, and elective procedures not covered by insurance.

• Consider using a credit card to prepay expenses that can generate deductions for this year.

• Increase your withholding if you are facing a penalty for underpayment of federal estimated tax. Doing so may reduce or eliminate the penalty.

• If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or make estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2012 if doing so won’t create an alternative minimum tax (AMT) problem.

• Take an eligible rollover distribution from a qualified retirement plan before the end of 2012 if you are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2012. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2012, but the withheld tax will be applied pro rata over the full 2012 tax year to reduce previous underpayments of estimated tax.

• You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.

•  You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.

• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $13,000 in 2012 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax. Savings for next year could be even greater if rates go up and/or the income from the transfer would have been subject to the 3.8% tax in the hands of the donor.

If you have questions, please call us. We can help you determine the best option for you.