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.

Congress Passes the “American Taxpayer Relief Act of 2012”

On January 1, 2013, the American Taxpayer Relief Act of 2012 (ATRA) passed the U.S. Senate by a vote of 89 to 8, and the U.S. House of Representatives by a vote of 257 to 167.  Pres. Obama signed the legislation on January 2, 2013.  Technically, the Bush tax cuts expired by the time ATRA was passed, so the politicians can boast that they “cut” taxes by $3.9 trillion over 10 years, even though with reference to the law that existed on December 31, 2012, ATRA raises taxes by $620 billion over 10 years.  The White House claimed that this is the first time in 20 years that Congress acted on a bipartisan basis to vote for significant new revenue (tax hikes).  However, there doesn’t appear to be any significant spending cuts enacted as part of ATRA, so this country has a long ways to go to get its spending problems under control.

One of the good things about the ATRA is that many of the provisions are permanent.  By some estimates, over 50% of the tax code consists of temporary provisions, causing complexity and uncertainty for many taxpayers and businesses.  Since there is a good chance of tax reform in the next few years as Congress deals with the national debt, even “permanent” provisions may turn out to be in fact, temporary.

The fiscal cliff consisted of several major problems occurring nearly simultaneously:  major income tax increases, expiration of the 2% payroll tax holiday, spending cuts in military and non-military budgets under the 2011 automatic “sequestration” provision, reaching the national debt ceiling, and expiration of the temporary continuing spending resolution (an actual federal budget hasn’t been enacted since the last budget ended September 30, 2010).  ATRA only addressed the income tax increases and pushed off the sequestration spending cuts for two months.  Therefore, the fiscal cliff battles will continue between now and March 2013, when all of the other problems must be addressed.

I will publish in-depth blog articles on the ATRA tax changes covering individual tax provisions, business tax provisions, and estate and gift tax provisions.

ATRA also made the following changes:

·       Unemployment benefits for the long-term unemployed were extended one year to December 31, 2013

·       The 27% cut in payments to doctors treating patients on Medicare is delayed one year to December 31, 2013

·       The 2008 Farm Bill expiration date is extended to September 30, 2013, which averts a potential spike in milk prices to nearly $8 a gallon!

·       The scheduled 2013 fiscal year inflationary pay increase for members of Congress is canceled.

Utah Pass-Through Entity Withholding Tax Rules

Utah defines a pass-through entity (PTE) as an entity whose income, gains, losses, deductions, and credits flow through (via a Schedule K-1) to its owners for purposes of paying income tax.  A PTE is subject to Utah withholding requirements if one or more of its owners is an entity or is a Utah nonresident individual.  Therefore, this withholding is not strictly a nonresident withholding tax.  Withholding is also required if the PTE has an entity owner, even if that entity-owner is located in Utah and is owned by Utah residents.

The PTE withholding tax began in 2009 and applied to general partnerships, limited partnerships, limited liability partnerships, limited liability companies (if classified as a partnership for federal income tax purposes), and S corporations.  Composite nonresident tax return filings were eliminated at that time.  Beginning in 2013, trusts and estates will also be classified as PTEs if they distribute (or are required to distribute) income to beneficiaries.  Entities that are disregarded for federal purposes are classified in the same manner as for federal income tax.

A PTE is required to withhold 5% on allocations to entity owners or nonresident individual owners of Utah business income and any non-business income derived from or connected with Utah sources.  Portfolio income is categorized separately from non-business income if the PTE owner is not required to include the portfolio income as Utah income.  Portfolio income is attributable to the state of the PTE owner's residency.  Portfolio income generally includes gross income from interest, dividends, royalties, capital gains, and certain other items if not earned in the ordinary course of the PTE's trade or business.

The withholding tax must be paid on or before the original due date (without extensions) for the PTE's tax return.  The PTE must provide a Utah Schedule K-1 to its owners showing the allocated withholding amount.

A PTE may elect a waiver of its Utah withholding requirement.  The waiver may be for one or more of its owners subject to withholding.  However, if the owner fails to file a Utah income tax return and pay its Utah tax, the PTE will be assessed the tax, including any interest and penalty.

A special rule applies if the PTE intending to elect a waiver is itself also owned by a PTE (a "downstream" PTE), and the downstream PTE is owned entirely by Utah resident individuals.  In this case, the waiver can only be elected if all of the downstream PTEs and Utah resident individuals file their tax returns and pay their Utah tax on or before the PTE's Utah tax return filing due date, including extensions.  This will require Utah resident individuals to file their extended tax returns one month earlier than otherwise allowed.  For example, assume XYZ, LLC operates a Utah business and is partially owned by ABC, Ltd. (a family limited partnership) that in turn is owned solely by Utah resident individuals.  Assume XYZ, LLC's and ABC, Ltd.'s tax return due dates are April 15th and that they have obtained five-month extensions (maximum extension period for partnerships) to September 15th.  Assume further that the Utah resident individuals have obtained six-month extensions (maximum extension period for individuals) moving the due date of their tax returns to October 15th.  In order for XYZ, LLC to be eligible to elect a waiver from the Utah withholding requirement applicable to the ownership interest held by ABC, Ltd., both ABC, Ltd. and all of its Utah resident individuals must file their Utah tax returns, and pay their Utah income tax, by September 15th, the filing due date for XYZ, LLC, even though the Utah resident individual income tax returns aren't due until October 15th.

Temporary Expansion of the Voluntary Worker Classification Settlement Program

On December 17, 2012, the IRS issued Announcement 2012-46 temporarily modifying the Voluntary Worker Classification Settlement Program originally established on September 21, 2011 (see prior post).  This is a program that reduces the penalties on employers who come forward to correct workers misclassified as independent contractors who instead should have been classified as employees.  There is not a bright-line test in properly classifying workers, and errors can be made.  In addition, workers classified as employees are much more costly to a business than if the workers were instead classified as nonemployees.  Examples of additional costs are payroll taxes, health insurance (if offered to employees), and retirement plan (if offered to employees) contributions.  Therefore, some businesses may have tended toward classifying workers as independent contractors.  If the IRS discovers that workers were misclassified, the IRS can impose years of back taxes, interest, and penalties on the employer.  In addition, the employer could be responsible for past overtime pay, retirement plan contributions, and other employee fringe benefits.  With potential penalties building up over the years, employers felt stuck with the problem without a low-cost way of correcting the misclassification. 

Under the 2011 settlement program, the employer was not eligible to participate if it had not issue all required Forms 1099 for their workers during the three prior years.  The modified program allows employers that did not file required Forms 1099 to participate in the settlement program, but only if application is made on or before June 30, 2013.  The cost of entering into the modified program is higher than the regular program. 

The modified settlement program enables eligible employers to obtain substantial relief from past taxes, penalties, and interest if they prospectively treat workers as employees. To be eligible, a business must:

 

1.    Have consistently treated the workers in the past as nonemployees,

2.    Not be currently under an employment tax audit by the IRS, and

3.    Not be currently under audit by the Department of Labor or by a state agency concerning the classification of these workers.

Eligible employers must file Form 8952 with the IRS by June 30, 2013.  Employers accepted into the program will be required to electronically file all required Forms 1099 for the prior three years, in accordance with IRS instructions that will be provided once the IRS has reviewed the application and verified that the employer is eligible for the modified settlement program. 

Employers accepted into the temporary, modified program will pay a penalty of from 1.26% to 1.97% of wages (up from about 1% under the regular program) paid to the reclassified workers for the past year.  The IRS will not audit the employer for payroll taxes related to these workers for prior years. 

In addition to the reduced payroll tax penalty, a reduced penalty on the late filing of Forms 1099 will apply.  The amount of the penalty is based upon the total number of Forms 1099 that should have been filed during the three prior years.  The amount penalty is: 

1.     From 1 to 25 non-filed forms, the lesser of $500 or $50 per form.

2.     From 26 to 49 non-filed forms, the lesser of $3,675 or $75 per form.

3.     For 50 or more non-filed forms, the lesser of $10,000 or $100 per form.

This is a voluntary Federal program.  Participation in the program could be shared with states that may or may not have a voluntary compliance program of their own.  Note also that correcting worker classification may have an impact under the 2014 health insurance mandate for employers having 50 or more employees beginning in 2013.

New W-2 Reporting Duty for "Large" Employers

As the year 2012 draws to a close, employers will be busy preparing Form W-2 for their employees.  Form W-2 must be provided to employees no later than January 31, 2013.  Under the new health care reform law, employers that filed 250 or more W-2's for 2011 (prepared in January 2012) are classifed as "large" employers for this purpose and must report the aggregatge cost of employer-provided health insurance on W-2's for 2012 (prepared in January 2013).  Employers that filed less than 250 W-2's for 2011 do not have to report the cost of health insurance on the W-2, even if they have 250 or more W-2s for 2012.

The cost is to be reported in box 12 of Form W-2 using the code "DD."  The cost is for information reporting only; it is not taxable compensation to the employees and therefore should not be included with other compensation reported in boxes 1, 3, or 5 of Form W-2.

The "aggregate cost" of employer-provided health insurance follows these general rules.  Be sure to check IRS Notice 2012-9 for your specific circumstances.

1. Include premiums paid by the employer.
2. Include premiums paid by the employee (whether pre-tax or after-tax).
3. Include COBRA premiums of former employees and beneficiaries.
4. Exclude pre-tax employee contributions to health flexible spending accounts.
5. Exclude contributions to a health savings account.
6. Exclude coverage for long-term care.
7. Exclude the cost of separate policies covering dental or vision.

The IRS has reserved the right to lower the 250 W-2 threshold in the future, so smaller employers may yet have to deal with this paperwork requirement.

Major Changes to the Estate and Gift Tax Looming

With the "fiscal cliff" discussions centering on income tax rates and spending cuts, don't forget about the major changes to the estate and gift tax system that take place on January 1, 2013.  The chart below outlines several of these changes, absent any new legislation.

	2012	2013
Annual gift tax exclusion	$13,000	$14,000
Lifetime gift & estate tax exclusion	$5,120,000	$1,000,000
Lifetime generation skipping tax exclusion	$5,120,000	$1,430,000
Top gift & estate tax rate	35%	55%
Flat generation skipping transfer tax rate	35%	55%
Portability of deceased spouse’s unused exemption amount	Available	Unavailable

In addition to these statutory changes, Pres. Obama has proposed a variety of changes to reduce or eliminate the benefits of certain estate and gift tax planning strategies.  Whether any of the following proposals will be enacted remains to be seen.  If enacted, these proposals could increase gift and estate taxes much more than the taxes raised from reduced lifetime exemption amounts.

·       Eliminate valuation discounts for the transfer of closely-held businesses or gifts among family members.

·       Grantor-retained annuity trusts may be required to have at least a 10-year term and some minimum gift amount that effectively eliminates the benefits of a short-term, zeroed-out GRAT.

·       Sales of assets to “defective” grantor trusts could be rendered ineffective by requiring the value of assets in such trusts to be taxed as part of the estate.

·       Dynasty or descendants’ trusts might be limited to 90 years in duration at which time the generation skipping tax could apply.

Although there isn’t much time left before the end of 2012, be sure to consider the following gift and estate tax planning strategies to secure tax benefits for your family that might not be available in full after 2012.  Note that estate planning attorneys are becoming booked with appointments and it could be difficult to draft and implement any sophisticated strategies by year-end if you wait much longer.

 

·       Be sure to make annual exclusion gifts.  While the annual exclusion amount renews each calendar year, any unused exclusions from previous years do not carry over.  Remember that checks must be cashed by December 31^st, so consider using cashier’s checks.

·       Direct payments of tuition to educational institutions and of medical expenses to health care providers do not count against either the annual or lifetime exclusion amounts.

·       Consider making a gift of the full $5.12 million to an irrevocable trust for your descendants.  A spousal lifetime access feature can be added if there is a concern about whether your spouse might need some benefits from these assets in the future.  The trust can also be designed to last for multiple generations without an estate tax being imposed at each generation.

·       Consider using a GRAT or a sale to a defective grantor trust as part of your estate planning.

Selected 2013 Inflation-Indexed Figures

Many contribution and deduction amounts in the tax law are indexed for inflation.  Many also have statutory adjustments.  While there remains substantial uncertainty about whether the “lame duck” Congress will enact any new tax laws before the end of 2012, some important 2013 inflation-adjusted figures have been released and are as follows:

·       The contribution amount for traditional and Roth IRAs is $5,500 (up from $5,000 in 2012).  For those who are age 50 and older in 2013, the additional “catch-up” contribution remains $1,000.

·       The modified adjusted gross income phase-out range for contributions to Roth IRAs is from $178,000 to $188,000 for joint filers (up from between $173,000 and $183,000 in 2012); and from $112,000 to $127,000 for single filers (up from $110,000 and $125,000 in 2012).

·       The contribution amount for traditional and Roth 401(k) accounts is $17,500 (up from $17,000 in 2012).  For those who are age 50 and older in 2013, the additional “catch-up” contribution remains $5,500.

·       The limit on the annual additions to a participant's defined contribution account is $51,000 (up from $50,000 in 2012).

·       The annual exclusion from gift tax is $14,000 per donee (up from $13,000 in 2012).

·       The personal exemption is $3,900 (up from $3,800 in 2012).

·       The Social Security tax wage base is $113,700 (up from $110,100 in 2012).

·       The maximum annual contribution to a health savings account is $3,250 (up from $3,100 in 2012) for an individual-coverage-only health plan, and $6,450 (up from $6,250 in 2012) for a family-coverage health plan.  For employees age 55 and older in 2013, the additional HSA "catch-up" contribution remains $1,000.