Tax Alert

Summary of Key Provisions of the American Taxpayer Relief Act

January 8, 2013

On January 1, 2013, Congress passed the American Taxpayer Relief Act (the “Act”). While the Act, now signed into law by President Obama, does increase income taxes for the highest-income individuals and raises transfer tax rates, it also prevents many of the tax increases that would otherwise have gone into effect and retains many favorable tax breaks that would otherwise have expired. This article provides a brief summary of several of the Act’s key provisions.

Key Provisions of the Act:

Top Ordinary Income Tax Rate Increased. Most income tax rates for individuals will stay the same at 10%, 15%, 25%, 28%, 33% and 35% (instead of increasing to 15%, 28%, 31%, 36% and 39.6% as would have occurred under prior law). However, a new top tax rate of 39.6% will now apply for taxable income over $450,000 for married taxpayers filing jointly and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. The thresholds will be adjusted for inflation in future tax years.

Top Capital Gain and Dividend Rates Increased. The highest tax rate for capital gains and dividends will rise from 15% to 20% for single taxpayers with taxable incomes exceeding $400,000 ($450,000 for married taxpayers filing jointly). After adding the new 3.8% “net investment income tax”, the top rate for highest-income taxpayers will be 23.8%.

Taxpayers whose income levels fall below the above thresholds but are subject to at least the 25% rate on ordinary income, will continue to be subject to a maximum 15% rate on capital gains and dividends (or 18.8%, where the 3.8% “net investment income tax” applies). For taxpayers subject only to tax rates below 25% on ordinary income, capital gains and dividends will be taxed at a 0% rate.

The example found here illustrates how the new capital gains rates are applied (prior to the application of the Net Investment Income Tax, described in our Tax Alert: New in 2013 -- Net Investment Income Tax and the Additional Medicare Tax).

Personal Exemption Phaseout Reinstated. The Personal Exemption Phaseout (“PEP”) is reinstated for individual taxpayers with adjusted gross incomes exceeding certain thresholds ($300,000 for married taxpayers filing jointly, $275,000 for heads of household, $250,000 for single filers, and $150,000 for married taxpayers filing separately). Under the PEP, the total amount of exemptions that can be claimed by a taxpayer is reduced by 2% for each $2,500 (or portion thereof) by which his or her adjusted gross income exceeds the applicable threshold. The thresholds will be adjusted for inflation in future tax years.

Pease Limitation on Itemized Deductions Reinstated. The “Pease“ limitation on itemized deductions is reinstated for individual taxpayers with adjusted gross incomes exceeding certain thresholds ($300,000 for joint filers, $275,000 for heads of household, $250,000 for single filers, and $150,000 for married taxpayers filing separately). Under the “Pease” limitation, the total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer’s adjusted gross income exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The thresholds will be adjusted for inflation in future tax years.

Transfer Tax Provisions Slight Rate Increase. The estate, gift and generation skipping transfer tax exemption will remain at $5,000,000 (as indexed for inflation), and the first spouse to die may still transfer his or her unused exclusion to the surviving spouse. However, the top transfer tax rate is increased from 35% to 40%.

AMT Relief. Individual AMT exemption amounts are now increased and indexed for inflation. In addition, an individual may now offset his or her entire regular tax liability and AMT liability by all nonrefundable personal credits.

Modification and Extension of Certain Depreciation Provisions. Fifty percent first year bonus depreciation has been extended for qualifying property placed in service before January 1, 2014. Certain other favorable depreciation provisions have been extended as well, including, for example: 15-year straight line cost recovery for qualified leasehold improvements; qualified restaurant buildings and improvements; and qualified retail improvements; increased expensing limitations and treatment of certain real property as Section 179 property; expensing of off-the-shelf computer software; and special expensing rules for certain film and television productions.

Extension of Certain Business Credits and Special Rules. Certain business credits and special rules are also extended, including for example: the Section 41 research credit; the Section 45P employer wage credit for employees who are active duty members of the uniformed services; 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 under Section 512(b)(13)(E)(iv); the exclusion of 100% of gain on certain small business stock acquired before January 1, 2014; the reduction to 5 years (from 10 years) of the S corporation recognition period for built-in gains under Section 1374(d)(7).

Morse, Barnes-Brown & Pendleton would be pleased to assist you in understanding and planning for the effects of the Act on your personal or business taxes. Please feel free to contact any member of our Tax practice group for assistance.

To ensure compliance with U.S. Treasury Regulations governing tax practice, we inform you that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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