2012 Taxpayer Relief Act Extends Tax Rate Cuts, Deductions, and Credits
On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (P.L. 112-240). The new law is intended to avert the tax side of the “fiscal cliff,” and was approved by both the Senate and the House on January 1, 2013. The 2012 Taxpayer Relief Act allows the Bush-era tax rates to sunset after 2012 for individuals with incomes over $400,000 and families with incomes over $450,000, but extends them for all other individuals; permanently “patches” the alternative minimum tax; revives many expired tax extenders, including the research and experimentation credit and the American Opportunity Tax Credit; and provides for a maximum estate tax rate of 40 percent with a $5 million exclusion. The bill also delays the mandatory across-the-board spending cuts known as sequestration.
Individual Income Tax Rates
The 2012 Taxpayer Relief Act makes permanent for 2013 and beyond the lower Bush-era income tax rates for all individuals, except for those with taxable income above certain thresholds: $400,000 for single taxpayers, $450,000 for married taxpayers filing joint returns and surviving spouses ($225,000 for married filing separate returns), and $425,000 for heads of households. Income above these levels will be taxed at a 39.6 percent rate.
The 10-, 15-, 25-, 28-, and 33-percent marginal rates remain the same after 2012, as does the 35-percent rate for income between the top of the 33-percent rate (projected to be at $398,350 for most taxpayers) and the $400,000/$450,000 threshold at which the 39.6-percent bracket now begins.
Individual marginal tax rates of 10, 15, 25, 28, 33, and 35 percent at the end of 2012, therefore, are now set going forward at the same 10-, 15-, 25-, 28-, 33-, and 35-percent rates, but with an additional 39.6-percent rate carved out from the old 35-percent bracket range.
Trusts and estates. The 2012 Taxpayer Relief Act similarly retains the Bush-era income tax rates for all bracket levels that apply to trusts and estates, except for the highest rate bracket. That top rate increases to 39.6 percent and applies to what was the entire 35-percent bracket range. The 39.6-percent bracket for trusts and estates is projected to begin in 2013 for taxable income in excess of $11,950.
Marriage Penalty Relief
The 2012 Taxpayer Relief Act extends all existing marriage penalty relief. Before the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), married couples experienced the so-called marriage penalty in several areas. EGTRRA gradually increased the size of both the 15-percent income tax bracket and the basic standard deduction for a married couple filing a joint return to twice their sizes for an unmarried individual filing a single return. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312) had extended EGTRRA’s marriage penalty relief only through 2012.
Capital Gains/Dividend Rates
The 2012 Taxpayer Relief Act raises the top rate for capital gains and dividends to 20 percent, up from the Bush-era maximum 15-percent rate. That top rate will apply to the extent that a taxpayer's income exceeds the same thresholds set for the 39.6-percent rate on ordinary income: $400,000 for single filers, $450,000 for joint filers ($225,000 for married filing separately), and $425,000 for heads of households.
All other taxpayers will continue to enjoy a capital gains and dividends tax at a maximum rate of 15 percent. A zero-percent rate also will continue to apply to capital gains and dividends to the extent income falls below the top of the 15-percent income tax bracket—projected for 2013 to be $72,500 for joint filers and $36,250 for singles. Qualified dividends for all taxpayers continue to be taxed at capital gains rates, rather than ordinary income tax rates as prior to 2003.
The 28- and 25-percent tax rates for collectibles and unrecaptured Code Sec. 1250 gain, respectively, continue unchanged after 2012. Also unchanged is the application of ordinary income rates to short-term capital gains; only long-term capital gains, those realized on the sale or disposition of assets held for more than one year, can benefit from the reduced net capital gain rate.
Generally, dividends received from a domestic corporation or a qualified foreign corporation on which the underlying stock is held for at least 61 days within a specified 121-day period are qualified dividends for purposes of the reduced tax rate. Certain dividends do not qualify for the reduced tax rates and are taxed as ordinary income. Those include (but are not limited to) dividends paid by credit unions, mutual insurance companies, and farmers' cooperatives.
Permanent AMT Relief
The 2012 Taxpayer Relief Act “patches” the alternative minimum tax for 2012 and subsequent years by increasing the AMT exemption amounts and allowing non-refundable personal credits to the full amount of the individuals regular tax and AMT. Additionally, the Act provides for an annual inflation adjustment to the exemption amounts and other amounts used in the AMT calculation for years beginning after 2012.
The 2012 Taxpayer Relief Act increases the 2012 exemption amounts to $50,600 for unmarried individuals; $78,750 for married taxpayers filing jointly and surviving spouses; and $39,375 for married taxpayers filing separately. The 2013 AMT exemption amounts are projected to be $80,750 for married filing jointly and qualified widow(er)s, $51,900 for single and head of household, and $40,375 for married taxpayers filing separately.
The 2012 Taxpayer Relief Act revives the “Pease” limitation on itemized deductions, which was eliminated by EGTRRA as extended by the 2010 Tax Relief Act. However, higher “applicable threshold” levels for adjusted gross income apply under the new law:
$300,000 for married couples filing jointly and surviving spouses;
$275,000 for heads of households;
$250,000 for unmarried taxpayers; and
$150,000 for married taxpayers filing separately.
The threshold amounts are adjusted for inflation for tax years after 2013.
The Pease limitation reduces the total amount of a higher-income taxpayer's otherwise allowable itemized deductions by three percent of the amount by which the taxpayer's AGI exceeds an applicable threshold. However, the amount of itemized deductions is not reduced by more than 80 percent. Certain items, such as medical expenses, investment interest, and casualty, theft or wagering losses, are excluded.
Personal Exemption Phase-out
The 2012 Taxpayer Relief Act also officially revives the personal exemption phase-out rules, but at applicable AGI threshold levels slightly higher than in the past:
$300,000 for married couples and surviving spouses;
$275,000 for heads of households;
$250,000 for unmarried taxpayers; and
$150,000 for married taxpayers filing separately.
Under the phase-out, the total amount of exemptions that may be claimed by a taxpayer is reduced by two percent for each $2,500, or portion thereof (two percent for each $1,250 for married couples filing separate returns) by which the taxpayer's AGI exceeds the applicable threshold level.
Estate, Gift, and GST Taxes
The 2012 Taxpayer Relief Act permanently provides for a maximum federal estate tax rate of 40 percent, with an annually inflation-adjusted exclusion of $5 million for estates of decedents dying after December 31, 2012.
The maximum estate tax rate for estates of decedents dying after December 31, 2010, and before January 1, 2013, is 35 percent with a $5 million exclusion (indexed for inflation for 2012 at $5.12 million). Effective January 1, 2013, the maximum federal estate tax rate had been scheduled to revert to 55 percent, with an applicable exclusion amount of $1 million (not indexed for inflation), which were the levels before enactment of estate tax reform in 2001 and subsequent legislation.
Portability. The 2012 Taxpayer Relief Act makes permanent the “portability” of a predeceased spouse’s unused exclusion amount to the surviving spouse. Prior to the permanent extension, portability was only available to the estates of decedents dying after December 31, 2010 and before January 1, 2013.
State death tax credit/deduction. The 2012 Taxpayer Relief Act extends the deduction for estate, inheritance, legacy, or succession taxes paid to a state, and permanently repeals the credit for such taxes.
More estate tax provisions. The 2012 Taxpayer Relief Act extends a number of provisions affecting qualified conservation easements, qualified family-owned business interests, the installment payment of estate tax for closely held businesses, and the repeal of the five-percent surtax on estates larger than $10 million.
Gift tax. The 2012 Taxpayer Relief Act provides a maximum 40-percent tax rate and a unified estate and gift tax exclusion of $5 million (inflation adjusted) for gifts made after 2012.
GST Tax. The 2012 Taxpayer Relief Act provides for a 40-percent generation-skipping transfer tax rate with a $5 million GST tax exemption, and extends a number of GST tax-related provisions scheduled to expire after 2012. They include the GST deemed allocation and retroactive allocation provisions; clarification of valuation rules with respect to the determination of the inclusion ratio for GST tax purposes; provisions allowing for a qualified severance of a trust for purposes of the GST tax; and relief from late GST allocations and elections.
The 2012 Taxpayer Relief Act makes a valuable change to the treatment of retirement savings and opens up an important planning opportunity. Generally, participants with 401(k), 403(b), or 457(b) plans have been allowed to roll over funds to designated Roth accounts in the same plan subject to certain qualifying events or age restrictions. The Act lifts most restrictions, and now allows participants in such plans with in-plan Roth conversion features to make transfers to a Roth account even if the participants is under age 59-1/2 (70-1/2 for 457(b) plans). Congress made this change because conversion is a taxable event and will raise revenue.
State and Local Sales Tax Deduction
The 2012 Taxpayer Relief Act extends through 2013 the election to claim an itemized deduction for state and local general sales taxes in lieu of state and local income taxes. Thus, because of the extension, taxpayers in states without income taxes continue to be able to elect to claim an itemized deduction for state (and local) general sales taxes.
Child Tax Credit
The 2012 Taxpayer Relief Act extends permanently the $1,000 child tax credit. The current provision that reduces the earnings threshold for the refundable portion of the child tax credit to $3,000 is extended through 2017.
Certain enhancements to the credit under Bush-era legislation and subsequent legislation are also made permanent: the offset of the nonrefundable child tax credit against regular tax and AMT, the repeal of the AMT offset applicable to the additional child credit for families with three or more children, and the repeal of the “supplemental child credit” under the earned income credit rules.
The $1,000 and $3,000 amounts are not adjusted for inflation.
Earned Income Credit
The 2012 Taxpayer Relief Act makes permanent enhancements to the earned income credit in Bush-era and subsequent legislation. The enhancements to the EIC made by Bush-era and subsequent legislation include (but are not limited to) a simplified definition of earned income, reform of the relationship test, and modification of the tie-breaking rule. In addition, the temporary increase in the credit percentage for taxpayers with three or more qualifying children from 40 percent to 45 percent, and a temporary $5,000 increase in a joint filer’s phaseout amount, have been extended through 2017. The IRS also has additional authority with respect to mathematical errors.
Other Child-Related Tax Provisions
Adoption credit/assistance. The 2012 Taxpayer Relief Act extends permanently Bush-era enhancements to the adoption credit and the income exclusion for employer-paid or reimbursed adoption expenses up to an inflation-adjusted amount (projected to be $12,770 for 2013), both for non-special needs adoptions and special needs adoptions.
Child and dependent care credit. The 2012 Taxpayer Relief Act extends permanently Bush-era enhancements to the child and dependent care credit. The current 35-percent credit rate is made permanent, along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.
Employer-provided child care credit. The 2012 Taxpayer Relief Act extends permanently the Bush-era credit for employers who provide certain child care facilities and services to their employees.
The 2012 Taxpayer Relief Act makes permanent or extends a number of enhancements to tax incentives designed to promote education. Many of these enhancements were made in Bush-era legislation and extended by subsequent legislation, but were scheduled to expire after 2012. Some enhancements, notably the American Opportunity Tax Credit, had been enacted in President Obama's first term.
American Opportunity Tax Credit. The 2012 Taxpayer Relief Act extends through 2017 the American Opportunity Tax Credit, which is an enhanced, but temporary, version of the permanent HOPE education tax credit. It rewards qualified taxpayers with a tax credit of 100 percent of the first $2,000 of qualified tuition and related expenses and 25 percent of the next $2,000, for a total maximum credit of $2,500 per eligible student. Additionally, the AOTC applies to the first four years of a student's post-secondary education. The HOPE credit, in contrast, is less generous and applies only to the first two years of a student's post-secondary education.
Deduction for qualified tuition and related expenses. The 2012 Taxpayer Relief Act extends through December 31, 2013, the above-the-line deduction for qualified tuition and related expenses. (The deduction is extended retroactively for the 2012 tax year.) The amount of the deduction is limited to a maximum of $4,000 for taxpayers whose modified AGI does not exceed $65,000 ($130,000 for joint filers), and $2,000 for taxpayers whose modified AGI exceeds $65,000 but does not exceed $80,000 ($130,000 and $160,000, respectively, for joint filers).
Student loan interest deduction. The 2012 Taxpayer Relief Act permanently removes the 60-month rule for the $2,500 above-the-line student loan interest deduction. It also makes permanent the increased modified AGI range for phase-out of the deduction, and repeals permanently the restriction that makes voluntary payments of interest nondeductible.
Coverdell Education Savings Accounts. The 2012 Taxpayer Relief Act extends permanently Bush-era enhancements to Coverdell education savings accounts. These enhancements include a $2,000 maximum contribution amount and treatment of elementary and secondary school expenses as well as post-secondary expenses as qualified expenditures.
Employer-provided education assistance. The 2012 Taxpayer Relief Act extends permanently the exclusion from income and employment taxes of employer-provided education assistance up to $5,250. The employer gets an offsetting deduction.
The $5,250 amount is not adjusted for inflation.
Federal scholarships. The 2012 Taxpayer Relief Act makes permanent the exclusion from income for scholarships with obligatory service requirements received by degree candidates at qualified educational organizations from the National Health Service Corps Scholarship Program and the Armed Forces Scholarship Program.
More Individual Income Tax Extenders
Teachers' classroom expense deduction. The 2012 Taxpayer Relief Act extends through 2013 the teacher's classroom expense deduction. The deduction, which had expired after 2011, allows primary and secondary education professionals to deduct (above-the-line) qualified expenses up to $250 paid out-of-pocket during the year.
Exclusion of cancellation of indebtedness on principal residence. Cancellation of indebtedness income is includible in income, unless a particular exclusion applies. This provision excludes from income up $2 million from the cancellation of mortgage debt on a principal residence. The 2012 Taxpayer Relief Act extends the provision for one year, through 2013.
Transit benefits. The 2012 Taxpayer Relief Act extends parity in transit benefits through December 31, 2013. These benefits are a tax-free fringe benefit to employees. Parity in the exclusion limit expired after 2011.
Mortgage insurance premiums. Mortgage insurance premiums are treated as deductible interest that is qualified residence interest and may be taken as an itemized deduction. The 2012 Taxpayer Relief Act extends this provision through December 31, 2013.
Qualified conservation contributions. The 2012 Taxpayer Relief Act extends for two years, through December 31, 2013, the rule for contributions of capital gain real property for conservation purposes that allows the contribution to be taken against 50 percent of the contribution base. The special rules for contributions by certain corporate farmers and ranchers are also extended for two years.
IRA distributions to charity. The 2012 Taxpayer Relief Act extends for two years, through December 31, 2013, the provision allowing tax-free distributions from individual retirement accounts to public charities, by individuals age 70-1/2 or older, up to a maximum of $100,000 per taxpayer each year. The Act also provides special transition rules. One rule allows taxpayers to recharacterize qualified charitable distributions made in January 2013 as made on December 31, 2012. The other rule permits taxpayers to treat a distribution from the IRA to the taxpayer made in December 2012 as a qualified charitable distribution, if transferred to charity before February 1, 2013.
Business Tax Provisions
Many popular but temporary tax extenders relating to businesses are included in the 2012 Taxpayer Relief Act. Among them are Code Sec. 179 small business expensing, bonus depreciation, the research tax credit, and the Work Opportunity Tax Credit.
Code Sec. 179 small business expensing. The 2012 Taxpayer Relief Act extends through 2013 enhanced Code Sec. 179 small business expensing. For tax years 2012 and 2013, the Code Sec. 179 dollar limit is $500,000 with a $2 million investment limit. The qualified real property allowance and the rule allowing off-the-shelf computer software are also extended.
Bonus depreciation. The 2012 Taxpayer Relief Act extends 50-percent bonus depreciation through 2013. Some transportation and longer-period production property is eligible for 50-percent bonus depreciation through 2014.
Bonus depreciation also relates to the vehicle depreciation dollar limits under Code Sec. 280F, which imposes dollar limitations on the depreciation deduction for the year in which a taxpayer places a passenger automobile in service within a business, and for each succeeding year. If bonus depreciation had not been extended, 2012 would have been the final year in which substantial first-year write-offs for the purchase of a business automobile would be available.
Research and experimentation credit. The 2012 Taxpayer Relief Act extends through 2013 the Code Sec. 41 research and experimentation credit, which expired after 2011. This incentive rewards taxpayers that increase their spending on qualified research activities with a tax credit.
Work Opportunity Tax Credit. The 2012 Taxpayer Relief Act extends through 2013 the Work Opportunity Tax Credit, which rewards employers that hire individuals from targeted groups with a tax credit. Under the revived WOTC, employers hiring an individual within a targeted group (generally, otherwise hard-to-employ workers) are eligible for a credit generally equal to 40 percent of first-year wages up to $6,000.
Qualified leasehold/retail improvements, restaurant property. The 2012 Taxpayer Relief Act extends through 2013 the 15-year recovery period for qualified leasehold improvements, qualified retail improvements, and qualified restaurant property.
More Business Tax Extenders
A number of other business tax extenders that expired after 2011 have been extended through 2013 by the 2012 Taxpayer Relief Act. They include, among others:
New Markets Tax Credit;
employer wage credit for activated military reservists;
Subpart F exceptions for active financing income;
look-through rule for related controlled foreign corporation payments;
railroad track maintenance credit;
seven-year recovery period for motorsports entertainment complexes;
100-percent exclusion for gain on sale of qualified small business stock;
reduced recognition period for S corporation built-in gains tax;
enhanced deduction for charitable contributions of food inventory;
tax incentives for empowerment zones;
Indian employment credit;
accelerated depreciation for business property on Indian reservations;
special expensing rules for qualified film and television productions;
mine rescue team training credit;
election to expense advanced mine safety equipment;
qualified zone academy bonds;
low-income tax credits for non-federally subsidized new buildings;
exclusion of military basic pay allowance for housing from income determinations for certain qualified residential rental projects;
treatment of dividends of regulated investment companies (RICs);
treatment of RICs as qualified investment entities;
tax benefits for S corporations making charitable donations of property;
New York Liberty Zone tax-exempt bond financing; and
economic development credit for American Samoa.
Not extended. Certain business provisions were not extended by the 2012 Taxpayer Relief Act. These include: enhanced deduction for corporate charitable contributions of book inventory; enhanced deduction for corporate charitable contributions of computers; tax incentives for the District of Columbia; and expensing of brownfields remediation costs