By Jennifer F. Flinchum, CPA, CFP®
Congress approved and President Obama signed The American Taxpayer Relief Act of 2012 (the “Act”), on January 2, 2013. This legislation was supposed to be the long awaited solution to the “fiscal cliff.” Discussion and debate continues, however, over how to manage and control the debt ceiling and federal spending. Many questions regarding future tax increases, closing of “loopholes” and who should bear the tax cost still remain. Also keep in mind that while we note that the changes are “permanent,” nothing would stop Congress from reconsidering the entire tax rate structure again as part of overall tax reform.
While there is still a good bit of uncertainty long term, the Act did provide extension of many key provisions impacting US businesses. A summary follows:
- Section 179 (Small Business Expensing of Depreciable Business Assets): Extended through 2013 the increased limits. For 2012 and 2013: Section 179 limit is $500,000 with a $2 million investment limit. Section 179 continues to include off the shelf computer software.
- Without the Act, the Section 179 limit for 2012 would have been $125,000 ($500,000 investment limit) and for 2013 would have been $25,000 ($200,000 investment limit). This was seen as a win for businesses as this extension was not widely discussed prior to the final legislation.
- Bonus Depreciation: Extended through 2013 the 50% bonus depreciation on new assets.
- Without the Act, there would have been no bonus depreciation for 2012 or 2013. As with the Section 179 extender, this was seen as a win for businesses.
- Qualified Leasehold/ Retail Improvements, Restaurant Property: The Act extended the shortened depreciable life of 15 years through 2013.
- Research Tax Credit: The Act extended the credit through 2013.
- Without the Act, there would have been no Research Tax Credit for 2012 or 2013.
- Work Opportunity Tax Credit: The Act extended the credit through 2013.
- Employer-Provided Child Care Credit: Permanently allows for a credit related to employer-provided child care facilities or services.
- Employer-Provided Education Assistance: Permanently extends the exclusion from an employee’s income the amount of employer-provided education assistance up to $5,250 annually.
- Various provisions extended through 2013: New Markets Tax Credit, 100% exclusion for gain on the sale of qualified small business stock, reduced recognition period for S Corporation Built-In-Gains tax
Items impacting owners of flow through entities (S corporations, Partnerships or LLCs):
We recognize that a majority of US businesses are structured as flow through entities and have included the provisions that will impact the tax applied to the income of these companies.
- Ordinary income tax rates: Permanently set the top marginal tax rate at 39.6% (up from 35% in 2012) for single taxpayers with taxable income over $400,000 and married filing joint taxpayers with taxable income over $450,000. These amounts will be annually increased for inflation.
- This is a bit better than some may have expected as the threshold is higher than the $200,000/ $250,000 of AGI proposed by President Obama and allows lower tax brackets to apply to income below the above mentioned thresholds.
- Capital Gain and Qualified Dividend tax rates: Permanently set the top rate on capital gains and qualified dividends at 20%. This rate is applicable to single taxpayers with taxable income over $400,000 and married filing joint taxpayers with taxable income over $450,000. For taxpayers below those limits, the 15% tax rate on capital gains and qualified dividends is still applicable. If taxable income falls below the 15% bracket, capital gains and qualified dividends will continue to be taxed at 0%.
- This compromise was seen as a win in an effort to avoid the tax on qualified dividends rising to the ordinary tax rate (as much as 39.6%) and tax on all long term capital gains rising to 20%.
- AMT exemption: Permanently increased the AMT exemption. For 2012, the AMT exemption will be $50,600 for single taxpayers and $78,750 for married filing joint taxpayers. These amounts will be increased annually for inflation. Permanently allows certain nonrefundable personal credits against the AMT.
- This is a welcome change to avoid the last minute passage of the “AMT patch.” Without the “AMT patch” some taxpayers would have had an increased liability of up to $9,450 in 2012.
- Phase out of Permanent Exemptions and Itemized Deductions: Permanently set the phase-out for single taxpayers with AGI over $250,000 and married filing joint taxpayers with AGI over $300,000. These amounts will be annually increased for inflation.
- This phase-out threshold is higher than expected. Without legislation, the expiration of the Bush era tax cuts would have provided a threshold of $178,750 for married filing joint taxpayers.
- Many were relieved that President Obama’s proposed limitation on the effective benefit of some itemized deductions (at 28%) was not included in the final legislation.
- Estate Tax: Permanently set the top estate tax rate at 40% for estates worth more than $5 million. This amount will be annually increased for inflation. The Act also makes permanent the “portability” between spouses for unused exclusion.
- This was considered a huge win for business owners. Without the Act, the exclusion would have reverted to $1 million with a tax rate of 55%.
- Gift Tax: Permanently set the gift tax at 40% and the gift tax exemption at $5 million. This amount will be annually increased for inflation.
Items that did not make the Act:
- Payroll tax reduction: There was no extension for the reduction in payroll taxes that was in effect in 2011 and 2012 (employee portion of FICA was 4.2% vs. 6.2%).
- Delay in Surtaxes (from Protection and Affordable Care Act of 2010): There was no reduction or delay new tax increases on earned income (.9% on wages or self employment income over $200k single or $250k married filing joint) and unearned income (3.8% on passive income from flow through entities such as S corporations, Partnerships or LLCs). These new taxes took effect on January 1, 2013.
For a full analysis of the ACT on both individuals and businesses, please refer to the link below: