Individual Tax Provisions of the American Taxpayer Relief Act of 2012

The ATRA was passed by Congress on January 1, 2013 and signed by Pres. Obama on January 2, 2013.  ATRA retroactively reinstated for 2012 certain expired provisions, and then raised income taxes on higher income individuals beginning in 2013.

Important changes to 2012 tax law (affecting 2012 income tax returns) include the following:

1.     The alternative minimum tax (AMT) exemption amount has been permanently “patched” for past inflation.  The 2012 exemption amounts are increased to $78,750 for joint filers; $50,600 for single filers; and $39,375 for married filing separately.  The increase insulates about 30 million taxpayers from the AMT.  The exemption will be indexed for inflation after 2012.

2.     Certain regular tax credits can reduce the AMT.  This provision expired December 31, 2011 but is reinstated for 2012 and made permanent.

3.     The $250 above-the-line deduction for certain expenses of elementary and secondary school teachers expired December 31, 2011.  It is reinstated for 2012 and extended through 2013.

4.     The deduction of mortgage insurance premiums expired December 31, 2011.  It is reinstated for 2012 and extended through 2013.

5.     The option to deduct state and local sales taxes (instead of state and local income taxes) expired December 31, 2011.  It is reinstated for 2012 and extended through 2013.

6.     The above-the-line deduction for qualified college tuition and related expenses expired December 31, 2011.  It is reinstated for 2012 and extended through 2013.

7.     The provision for those age 70 ½ or older to make tax-free direct IRA distributions of up to $100,000 per year to public charities expired December 31, 2011.  It is reinstated for 2012 and extended through 2013 with special transition rules.  A subsequent blog article will address this subject in more detail.

8.     The residential energy credit with a lifetime limit of $500 (of which only $200 can be used for windows and skylights) expired December 31, 2011.  It is reinstated for 2012 and extended through 2013.

Important changes to 2013 tax law include the following:

1.     The lower “Bush” ordinary income tax rates are made permanent after 2012 except that a new 39.6% rate applies to taxable income above certain thresholds.  The thresholds are $450,000 for joint filers; $400,000 for single filers; $425,000 for head of household; and $225,000 for married filing separately.  These thresholds are indexed for inflation after 2013.  The estimated taxable income brackets for a married taxpayer filing a joint return are:

2012 Rate Bracket	2012	2013 Rate Bracket	2013
$0 to $17,400	10%	$0 to $17,850	10%
$17,401 to $70,700	15%	$17,851 to $72,500	15%
$70,701 to $142,700	25%	$72,501 to $146,400	25%
$142,701 to $217,450	28%	$146,401 to $223,050	28%
$217,451 to $388,350	33%	$223,051 to $398,350	33%
$388,351 to $450,000	35%	$398,351 to $450,000	35%
$450,001 and up	35%	$450,001 and up	39.6%

 

2.     The lower “Bush” long-term capital gain and qualified dividend income tax rates are made permanent after 2012 except that a new 20% rate applies to such income above certain thresholds.  The thresholds are $450,000 for joint filers; $400,000 for single filers; $425,000 for head of household; and $225,000 for married filing separately.  These thresholds are indexed for inflation after 2013.  For taxpayers whose ordinary income (O.I.) tax rate is below 25%, the special 0% rate is made permanent for long-term capital gains and qualified dividends.  For taxpayers whose O.I. tax rate is from 25% to 35% (e.g. having income below the threshold at which the 39.6% rate applies), the top rate of 15% will apply to long-term capital gains and qualified dividends.  The special five-year, super-long term holding period tax rate of 18% that was to start in 2013 no longer applies.

LTCG and Qualified Dividend	2012	2013
10% and 15% O.I. rates	0%	0%
25% through 35% O.I. rates	15%	15%
39.6% O.I. rate	15%	20%

3.     After 2012, the deduction for personal exemptions phases-out (PEP) by 2% for each $2,500 (or portion thereof) by which adjusted gross income (AGI) exceeds a threshold amount.  For married filing separately, the PEP is 2% for each $1,250 (or portion thereof) by which AGI exceeds the threshold amount.  The threshold amounts are $300,000 for joint filers; $250,000 for single filers; $275,000 for head of household; and $150,000 for married filing separately.  All of the personal exemptions will be phased-out once AGI exceeds $122,500 above these threshold amounts.  The marginal tax rate on income earned in the phase-out range increases by approximately 1.0% point per personal exemption.  PEP is now a permanent provision and the thresholds are indexed for inflation after 2013.

Example:  Bob and Mary are married with two dependent children.  The 2013 personal exemption amount is estimated to be $3,900 per person.  The total amount of personal exemptions is $15,600.  Assume AGI is $403,000.  The amount in excess of $300,000 is $103,000.  Dividing $103,000 by $2,500 equals 41.2.  The percentage phase-out is 2% times 42 equals 84%.  The amount of disallowed personal exemptions $15,600 times 84% or $13,104.  Therefore, the deductible portion equals $2,496.

4.     After 2012, the deduction for certain itemized deductions (e.g. state and local income, sales, or property tax; home mortgage interest; charitable contributions; and miscellaneous itemized) is reduced by the amount equal to 3% of the excess of AGI over a threshold amount.  The total reduction cannot exceed 80% of the total.  The reduction does not apply to itemized deductions for medical expenses; investment interest expense; or casualty, theft, or wagering losses.  The provision for reducing itemized deductions is sometimes called the “Pease” limitation, named after the Congressman who originally proposed this provision that started back in 1991.  The amounts are $300,000 for joint filers; $250,000 for single filers; $275,000 for head of household; and $150,000 for married filing separately.  The marginal tax rate on income earned in the phase-out range increases by approximately 1.2% points at the top ordinary rate.  The Pease limitation is now a permanent provision and the thresholds are indexed for inflation after 2013.

Example:  Assume Bob and Mary have itemized deductions from taxes, home mortgage interest, and charitable deductions totaling $60,000 and that their AGI is $403,000.  The amount in excess of $300,000 is $103,000.  Multiplying $103,000 by 3% equals $3,090.  The itemized deduction equals $60,000 minus $3,090 or $56,910.

5.     The American Opportunity tax credit, which provides a more generous tax credit for certain expenses of the first four years of college, was to expire December 31, 2012.  It is extended through 12/31/2017.

6.     The exclusion for the discharge of qualified principal residence indebtedness of up to $2 million was to expire December 31, 2012.  It is extended for discharges through December 31, 2013.

7.     Retirement plans may adopt a permanent provision allowing employees to make a direct Roth conversion (after 2012) of a traditional 401(k), 403(b), or 457(b) governmental plan amount to a designated Roth 401(k), Roth 403(b), or Roth 457(b) governmental plan account in the same retirement plan.  Previously, a direct conversion was only possible if the employee had a right to withdraw money from the plan (e.g. because of attaining age 59 ½ or separation from service).

8.     The enhanced child tax credit of $1,000 is permanently extended past 2012.

9.     The marriage penalty relief pertaining to the standard deduction and the 15% ordinary rate bracket is permanently extended past 2012.  However, the ATRA thresholds for the top rate brackets and deduction limitations make the marriage penalty worse.

10.  The enhanced Coverdell Education Savings Account annual contribution limit of $2,000 is permanently extended past 2012.

11.  The expanded exclusion of up to $5,250 for employer-provided educational assistance is permanently extended past 2012.

12.  The expanded student loan interest deduction of $2,500 is permanently extended past 2012.

13.  The expanded dependent care tax credit is permanently extended past 2012.

14.  The increased adoption tax credit and the adoption assistance program exclusion are permanently extended past 2012.

15.  The Social Security tax rate for employees was temporarily reduced from 6.2% to 4.2% for 2011 and 2012.  The rate permanently returns to 6.2% in 2013.  For those with wages at or above the 2013 Social Security tax ceiling of $113,700; this will be a $2,274 tax increase.

Finally, don’t forget the Obamacare 2013 tax increases that come on top of the ATRA increases.  These are an additional 0.9% tax on compensation above certain thresholds, and an additional 3.8% tax on net investment income when modified AGI exceeds certain thresholds.  See my blog posts of July 13, 2012 and August8, 2012 for the details.