Congress Passes Bill to Avoid Fiscal Cliff

The House and Senate passed H.R.8, the "American Taxpayer Relief Act" (the Act) on Tuesday, January 1, 2013.

Highlights of the Act include:

Tax rates. For 2013, the income tax rates will stay the same, but with a 39.6% rate applying for income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. These dollar amounts are inflation-adjusted for tax years after 2013. The marriage penalty has been reinstated for those in the highest bracket.

PEP limitations to apply to high-earners. For 2013, the Personal Exemption Phaseout (PEP) is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. These dollar amounts are inflation-adjusted for tax years after 2013.

Pease limitations to apply to high-earners. For tax years beginning after 2012, the Pease limitation on itemized deductions is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) 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 adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013.

Capital gain and dividend rates rise for higher-income taxpayers. For 2013, the top rate for capital gains and dividends will permanently rise to 20% for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). Total rate would be 23.8% including the 3.8% surtax from the Affordable Care Act.

For taxpayers whose ordinary income is generally taxed at a rate below 25%, capital gains and dividends will permanently be subject to a 0% rate. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends. The rate will be 18.8% for those subject to the surtax.

Transfer tax provisions kept intact with slight rate increase. The Act prevents steep increases in estate, gift and generation-skipping transfer (GST) tax that were slated to occur for individuals dying and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation). However, the Act also permanently increases the top estate, gift and rate from 35% to 40%. The Act also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion to the surviving spouse. All changes are effective for individuals dying and gifts made after 2012.

Permanent AMT relief. The Act permanently increases the 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, it indexes these exemption amounts for inflation.

Historical individual extenders. The Act extends the following items for the period indicated beyond their prior termination date as shown in the listing:

• the deduction for certain expenses of elementary and secondary school teachers, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• the treatment of mortgage insurance premiums as qualified residence interest, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• the option to deduct State and local general sales taxes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013.
• the special rule for contributions of capital gain real property made for conservation purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• the above-the-line deduction for qualified tuition and related expenses, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013; and
• tax-free distributions from individual retirement plans for charitable purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013. Because 2012 has already passed, a special rule permits distributions taken in 2012 to be transferred to charities for a limited period in 2013. Another special rule permits certain distributions made in 2013 as being deemed made on Dec. 31, 2012.

Depreciation provisions modified and extended.15-year straight line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements was extended. There are increased expensing limitations for Section 179 property. The Act also extends the 50% bonus depreciation provisions with respect to property placed in service after Dec. 31, 2012, in tax years ending after that date.

Business tax breaks extended. The following business credits and special rules are also extended:

• Exclusion of 100% of gain on certain small business stock acquired before Jan. 1, 2014.
• Basis adjustment to stock of S corporations making charitable contributions of property under Code Sec. 1367(a) in tax years beginning before Dec. 31, 2013.

Pension provision. For transfers after Dec. 31, 2012, in tax years ending after that date, plan provisions in an applicable retirement plan (which includes a qualified Roth contribution program) can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution under Code Sec. 408A(e).

Medicare Reimbursements The Act also avoids a 27 percent 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).

Dairy Subsidy It also renews a price support program for the dairy industry to prevent a sharp increase in milk prices, as well as blocks a pay increase for Congress.

Unemployment In addition, the Act will prevent 2 million people from losing unemployment insurance benefits in January by extending emergency unemployment insurance benefits for one year.

S Corp Provison. If an S corp election is made in 2012 or 2013 by a C corporation, the look back period for determination of recognition of any built-in gains is reinstated to 5 years. The period was set to revert to 10 years.

R&D Credits extended. The R&D credits expiration was extended to December 31, 2013.

Items that were not extended or changed:

FICA tax reduction. The temporary reduction in the employee's FICA expired on December 31, 2012 and was not extended by the new bill. Employees will revert to paying 6.2% on wages subject to FICA.

Excise Tax on Medical Devices. The hotly contested Obamacare excise tax on the gross sales price of medical devices was not addressed in the bill. Therefore, a 2.3% excise tax on the gross selling price of all medical devices goes into effect as of January 1, 2013.