The “American Taxpayer Relief Act” (ATRA) was a stop-gap measure that raised rates on the wealthy, extended unemployment benefits, and averted a sweeping round of tax increases and government spending cuts. This New Year’s tax compromise includes provisions likely to both help and hinder entrepreneurs going forward. Daszkal Bolton clients should be relieved that the Act extended various tax breaks used by many businesses, especially the “bonus” depreciation rule, allowing the expensing of 50% of the cost of qualified property acquired and placed in service by the taxpayer before January 1, 2014 (or January 1, 2015, in the case of certain property eligible for a one-year extension of the placed-in-service date).
Here’s a look at some of the measures that will have the greatest impact on start-ups and small businesses.
Top rates raised: Tax rates will permanently increase for families with income above $450,000 and individuals above $400,000, meaning that a small sliver of small business owners with pass-through income above those thresholds will pay higher taxes. The Bush-era cuts remain in place for the rest of the tax brackets.
R&D credit continued: The Research and Development (R&D) tax credit was extended for another year and reinstated retroactively for 2012, though lawmakers stopped short of making it permanent. Employers can now continue to get tax breaks for between roughly 6% and 14% of their R&D expenditures. The credit is 20% of the amount by which a taxpayer’s qualified research expenditures exceed its base amount for the year, or 14% lower than the simplified credit rules. The lion’s share of R&D tax credits (80%) seems to go to the big players with $250 million or more in gross receipts. Smaller companies, often thought an important engine of economic innovation, use a modified version of the tax code to calculate the credit, the “Alternative Simplified Credit” formula. Remember R&D is about an enormous range of activities, like improving an existing product, making a building greener, or reducing the costs to make a product. The credit can also apply to a wide scope of industries — not just manufacturing, but computer software, architects, engineers, and food processing firms.
Section 179 continued: Congress renewed for another year the maximum deduction levels for bonus depreciation and Section 179, which give tax breaks to businesses that purchase or lease software and equipment — both provide a boost for small employers planning to invest back into their firms in 2013.
More targeted breaks continued: The Work Opportunity Tax Credit (WOTC), a tax incentive for firms that hire widely underemployed groups like youths and veterans, as well as breaks for renewable energy technologies and retail/restaurant improvements were extended through 2013.
Payroll taxes increased: Lawmakers did not save the payroll tax cuts, instead allowing rates to jump back up to 6.2% from 4.2% for all Americans. Economists warned the move could cripple consumer spending — a bad sign for small businesses who have already been complaining of low customer demand.
Capital gains rates increased: While dividend rates didn’t tick up nearly as much as the White House had hoped, capital gains and dividends did nudge slightly higher to 20% for high-income earners, which entrepreneurship advocates fear could deter some investments in new and growing firms.
Daszkal Bolton individual clients will see some of the biggest tax changes in years, including an increase in tax rates for couples with incomes over $450,000, to 39.6%. The tax rate on dividends and capital gains will remain at 15 percent for households under $450,000, and increase to 20% for higher-income Americans (what it was under President Clinton). Counting the 3.8% surcharge from the Affordable Care Act, dividends and capital gains would be taxed at a rate of 23.8% for high-income households. The bill keeps the estate tax exemption at $5 Million per individual, but raises the estate tax rate to 40%. It will also slightly increase transfer tax rates. The permanent patch for the AMT applies retroactively for 2012 and indexes the AMT for inflation to keep it from spreading to 30 million more middle-class taxpayers. That will make life easier for the accountants and tax planners at Daszkal Bolton, not to mention lawmakers in Congress, who needed to contend with patching the AMT year after excruciating year!!!
Below is a general summary and review of ATRA:
What the American Taxpayer Relief Act (ATRA) bill did not do:
The deal did not include an extension of the 2011 and 2012 payroll tax cut on Social Security tax withholding from paychecks, so most workers will see their Social Security taxes rise from 4.2% to 6.2%. And NOT ALL of the so-called “Bush tax cuts” were extended. For example:
• The 35% individual income tax bracket was not extended. Accordingly, for individuals with income of more than $400,000 (or $450,000 for married taxpayers filing joint returns), the top income tax bracket reverts to 39.6 percent for 2013; and
• The phase-outs of the personal exemptions (PEP) and the limitation on itemized deductions (Pease) are reinstated for individuals with income of more than $250,000 (or $300,000 for married taxpayers filing joint returns).
What the American Taxpayer Relief Act (ATRA) bill did do:
Income Tax Rates. For tax year 2013 and thereafter, the income tax rates for most individuals will remain at the 2012 levels of 10, 15, 25, 28, 33 and 35%. However, the Act introduces a 39.6% rate for some income of certain high-income taxpayers. This 39.6% rate only applies to income in excess of $450,000 for joint filers and surviving spouses, $425,000 for heads of household, $400,000 for single filers and $225,000 for married taxpayers filing separately. These dollar amounts will be inflation-adjusted for tax years after 2013. ATRA extends all existing marriage penalty relief.
Capital Gains/Dividends. Long-term capital gains and “qualified dividends” will, for most taxpayers, continue to be taxed at a maximum rate of 15%, with those persons in the 10% and 15%income tax brackets continuing to be exempt from further tax on long-term capital gains and qualified dividends. Qualified dividends are dividends paid by U.S. corporations and dividends paid by “qualified foreign corporations,” which are foreign corporations located in a U.S. possession or in a country with which the United States has a comprehensive income tax treaty that contains an information exchange program, and which the IRS has approved for this purpose. However, those taxpayers who are subject to the 39.6% income tax rate explained immediately above will be subjected to an increased 20% tax rate on such capital gains and dividends.
Federal Estate, Gift, and GST Taxes, Transfer Taxes. ATRA permanently provides for a maximum federal estate tax rate of 40% with an annually inflation adjusted $5 Million exclusion for estates of decedents dying after December 31, 2012. The Act retains the 2012 estate and gift tax exemption amount of $5 million (indexed for inflation, with 2011 as the base year), but increases the federal estate and gift tax rates on transfers in excess of this amount from 35 to 40%. For 2013, the inflation-adjusted exemption amount is expected to be $5.25 Million.
The Act also continues the portability feature of the estate tax law, which allows a surviving spouse to utilize his or her deceased spouse’s unused exemption amount, and makes permanent many other technical amendments to the transfer tax law that have been enacted over the past 12 years. The deduction for state estate taxes has been extended, as well as a number of GST tax related provisions due to sunset in 2012.
PEP limitations for High-Earners. For tax years beginning after 2012, the Act reinstates the Personal Exemption Phase-out (PEP), which previously had been suspended, with a starting threshold of adjusted gross income (AGI) above $300,000 for joint filers and surviving spouses, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately. Under the phase-out, the total amount of exemptions that may be claimed by a taxpayer who is subject to the limitation is reduced by 2% for each $2,500 (or a portion thereof) by which the taxpayer’s AGI exceeds the relevant threshold. These dollar amounts will be inflation-adjusted for tax years after 2013. Pease limitations for High-Earners. For tax years beginning after 2012, the Act also reinstates the “Pease” limitation on itemized deductions, which had previously been suspended, with a starting threshold of AGI above $300,000 for joint filers and surviving spouses, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer’s AGI exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The Pease limitation affects all deductions, including the charitable donation deduction and the deduction for home mortgage interest. These dollar amounts will be inflation-adjusted for tax years after 2013.
Alternative Minimum Tax (AMT). The Act provides some permanent AMT relief for tax years 2012 and later by retroactively increasing the applicable exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, the Act automatically indexes these exemption amounts for inflation.
Also, prior to the Act, nonrefundable personal credits, other than the adoption credit, the child credit, the savers’ credit, the residential energy efficient property credit, the non-depreciable property portions of the alternative motor vehicle credit, the qualified plug-in electric vehicle credit and the new qualified plug-in electric drive motor vehicle credit, were allowed only to the extent that the individual’s regular income tax liability exceeded his tentative minimum tax, determined without regard to the minimum tax foreign tax credit. Retroactively effective for tax years beginning after 2011, the Act permanently allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits. Exclusion of Small Business Capital Gains and Other Business Deductions. Generally, non-corporate taxpayers may exclude 50% of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, the exclusion is increased to 75%. For stock acquired after September 27, 2010 and before January 1, 2011, the exclusion is 100% and the AMT preference item attributable for the sale is eliminated. The Act extends for one year the 100% exclusion of the gain from the sale of qualifying small business stock through 2013.
The Act includes a one-year extension of current “bonus” depreciation rules, which allow businesses to deduct up to 50% of the cost of a wide variety of property and equipment, excluding real estate. The Section 179 small business expensing dollar limit of $500,000 is a big deal. ATRA extends through 2013 enhanced small business expensing. The dollar limit for tax years 2012 – 2013 is $500,000 with a $2 Million investment limit. The rule allowing off the shelf computer software is also extended.
Increase in Employee-Paid Payroll Taxes. The two percent payroll tax holiday that taxpayers have enjoyed for the past two tax years is allowed to expire under the Act (the reduction had decreased the rate from 6.2 to 4.2%). For an individual earning the maximum 2013 cap of $113,700 or more, this increase will amount to $2,274 in 2013.
Unemployment Benefits. The Act includes a one-year extension of unemployment insurance benefits.
Other Miscellaneous Deductions and Credits. The Act extends provisions allowing deductions for $250 of teachers’ classroom expenses, tuition and related expenses and state sales taxes in lieu of state income taxes. It extends through 2013 the provision allowing tax free distributions from IRAs to public charities by account owners age 70.5 and older, of up to $100,000 per taxpayer per year.
The Act also extends for five years the American Opportunity Tax Credit. For many taxpayers this dollar-for-dollar credit is worth up to $2,500. The Act also would extend for five years the current versions of the Child Tax Credit and Earned Income Tax Credit, which are claimed by many lower-income workers making up to approximately $50,000.
Additionally, the Act extends through 2013 the exclusion of certain income from the discharge of qualified principal residence indebtedness. The provision that treats mortgage insurance premiums as deductible qualified residence interest is extended through December 31, 2013.
The Act extends the lifetime energy credit limit at the $500 level for individuals who make energy efficiency improvements to their residence through December 31, 2013
The Act avoids a 27% cut to reimbursements for doctors seeing Medicare patients for 2013 by fixing the sustainable growth rate formula through the end of next year (the “doc fix”), thus preventing Medicare providers from facing substantial cuts in reimbursement that were otherwise scheduled to take effect.
The Act also renews a price support program for the dairy industry to prevent a sharp increase in milk prices.
Congress also extended the ability to convert from a regular IRA to a Roth IRA without paying an early withdrawal penalty.
What does the Future Hold?
Business leaders and accountants alike hoped that a fiscal cliff deal would include provisions that would require Congress to begin work to simplify the tax code. That not only didn’t happen, but tax reform looks less likely now, given how hard it was for Congress to do something relatively simple, such as avoiding its self-made fiscal cliff.
Due to the late passage of the fiscal cliff legislation, the IRS said it would begin accepting individual tax returns on January 30th after updating its forms and completing the programming and testing of its processing systems. This will reflect the bulk of the late tax law changes enacted January 2nd. The announcement means that the vast majority of tax filers—more than 120 million households—should be able to start filing tax returns starting January 30th.
The IRS estimates that remaining households will be able to start filing in late February or into March because of the need for more extensive form and processing systems changes. This group includes people claiming residential energy credits, depreciation of property or general business credits. Most of those in this group file more complex tax returns and typically file closer to the April 15 deadline or obtain an extension. The IRS has already begun processing some business tax returns The key forms that require more extensive programming changes include Form 5695 (Residential Energy Credits), Form 4562 (Depreciation and Amortization) and Form 3800 (General Business Credit).
The IRS said it anticipates that the vast majority of all taxpayers can file starting January 30th, regardless of whether they file electronically or on paper. The IRS will be able to accept tax returns affected by the late AMT patch as well as the three major “extender” provisions for people claiming the state and local sales tax deduction, higher education tuition and fees deduction and educator expenses deduction.
Contact Us: This brief overview of some important considerations associated with the American Taxpayer Relief Act of 2012 is by no means comprehensive. Always seek the advice of a competent accounting professional when making important individual or business financial decisions. Now that the veil of uncertainty has been lifted, Jeff Bolton, CPA, Partner, advises it is time to start tax planning for 2013. Please contact Jeff at 561-367-1040, or at [email protected] if you have questions regarding ATRA’s impact on your business or individual tax bill.