2012 Taxpayer Relief Act Protects Key Individual Tax Breaks
On Jan. 1, 2013, Congress passed the American Taxpayer Relief Act (2012 Taxpayer Relief Act), which the President has vowed to sign as soon as it is ready for his signature. The 2012 Taxpayer Relief Act will prevent many of the tax hikes that were scheduled to go into effect this year and retain many favorable tax breaks that were scheduled to expire, but will also increase income taxes for some high-income individuals and slightly increase transfer tax rates from 2012 levels. Further, it extends a host of expired and expiring tax breaks for individuals.
Elimination of EGTRRA Sunsetting
The provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), other than those made permanent or extended by subsequent legislation, were set to sunset and no longer apply to tax or limitation years beginning after 2010. (Sec. 901 of EGTRRA) However, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act) extended the EGTRRA provisions for two additional years. Thus, under pre-2012 Taxpayer Relief Act law, beginning in 2013, the EGTRRA sunset (as extended) would have wiped out a host of favorable tax rules, such as: favorable income tax rate structure for individuals; marriage penalty relief; and liberal education-related deduction rules.
New law. The 2012 Taxpayer Relief Act eliminates the provision in EGTRRA that calls for its provisions to sunset. Accordingly the provisions in EGTRRA are made permanent and no longer automatically sunset in future years.
Reduced Individual Tax Rates Except for Higher-Income Taxpayers
New law. For tax years beginning after 2012, the income tax rates for most individuals will stay at 10%, 15%, 25%, 28%, 33% and 35% (instead of moving to 15%, 28%, 31%, 36% and 39.6% as would have occurred under the EGTRRA sunset). However, a 39.6% rate will apply for income above a certain threshold (specifically, income in excess of the “applicable threshold” over the dollar amount at which the 35% bracket begins). The applicable threshold is $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.
In addition, with the elimination of the EGTRRA sunset, the size of the 15% tax bracket for joint filers and qualified surviving spouses remains at 200% of the 15% tax bracket for individual filers.
Reduced Capital Gains & Qualified Dividends Rate Except for Higher-Income Taxpayers
New law. For tax years beginning after 2012, the 2012 Taxpayer Relief Act eliminates the provision in JGTRRA that provides for its provisions to sunset. Accordingly the provisions in JGTRRA are made permanent and no longer automatically sunset in future years.
For tax years beginning after 2012, the 2012 Taxpayer Relief Act provides that the top rate for capital gains and dividends will permanently rise to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When accounting for the 3.8% surtax on investment-type income and gains for tax years beginning after 2012, the overall rate for higher-income taxpayers will be 23.8%.
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. The rate will be 18.8% for those subject to the 3.8% surtax (i.e, those with modified adjusted gross income (MAGI) over $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
No Phase-Out of Personal Exemptions Except for Higher-Income Taxpayers
New law. For tax years beginning after 2012, the Personal Exemption Phaseout (PEP), which had previously been suspended, is reinstated with a starting threshold of $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.
No 3%/80% Limitation on Itemized Deductions Except for Higher-Income Taxpayers
New law. For tax years beginning after 2012, the 2012 Taxpayer Relief Act provides that the “Pease“ limitation on itemized deductions, which had previously been suspended, is reinstated with a starting threshold of $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.
AMT Exemption Permanently Increased With Indexing
The alternative minimum tax (AMT) is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%.
New law. Retroactively effective for tax years beginning after 2011, the Act permanently increases the AMT 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.
Personal Nonrefundable Credits May Offset AMT and Regular Tax for All Tax Years
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 to be allowed for 2012 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.
Thus, under pre-Act law, many nonrefundable personal credits couldn’t offset AMT. The AMT could also indirectly limit a taxpayer’s nonrefundable personal tax credits even in situations where the taxpayer wasn’t liable for the AMT.
New law. 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.
The rule allowing nonrefundable personal credits to reduce the AMT (as well as regular tax) benefits middle income individuals who: (a) have low taxable income (and thus a low regular tax), e.g., because of a large number of personal exemptions; (b) are subject to the AMT because personal exemptions (as well as the standard deduction and certain itemized deductions) generally are not allowed in computing the AMT; and (c) have substantial nonrefundable personal credits.
Individual Tax Breaks Retroactively Reinstated and Extended by the 2012 Taxpayer Relief Act
Above-the-Line Deduction for Educator Expenses Reinstated and Extended
Eligible elementary and secondary school teachers may claim an above-the-line deduction for up to $250 per year of expenses paid or incurred for books, certain supplies, computer and other equipment, and supplementary materials used in the classroom.
New law. The 2012 Taxpayer Relief Act retroactively extends the educator expense deduction for two years so that it applies to expenses paid in incurred in tax years 2012 and 2013.
Exclusion for Discharged Home Mortgage Debt Extended
Discharge of indebtedness income from qualified principal residence debt, up to a $2 million limit ($1 million for married individuals filing separately) is excluded from gross income.
New law. The 2012 Taxpayer Relief Act extends this exclusion for one year so that it applies to home mortgage debt discharged before 2014.
Increase in Excludible Employer-Provided Mass Transit and Parking Benefits Reinstated and Extended
For 2011, an employee could exclude from gross income up to $230 per month in employer-provided mass transit and parking benefits. However, for 2012, the exclusion rose to $240 for parking due to an inflation adjustment, but it fell to $125 for employer-provided transit and vanpooling benefit, creating a disparity with other qualified transportation fringe benefits. Under pre-Act law, this disparity was scheduled to continue for post-2012 years, and mass transit and vanpool benefits extended to employees would only be excludable up to $125 per month.
New law. The 2012 Taxpayer Relief Act retroactively extends this increase in the monthly exclusion for employer-provided transit and vanpool benefits, so that the exclusion for employer-provided transit and vanpool benefits is equal to that of the exclusion for employer-provided parking benefits, through 2013.
As a result of indexing changes, the exclusion is $245 per month in 2013.
It’s unclear how a taxpayer could actually take advantage of these retroactively increased benefits for 2012. Presumably, this issue will be addressed in future IRS guidance.
Treatment of Mortgage Insurance Premiums as Deductible Qualified Residence Interest Reinstated and Extended
Mortgage insurance premiums paid or accrued by a taxpayer in connection with acquisition indebtedness with respect to the taxpayer’s qualified residence are treated as deductible qualified residence interest, subject to a phase-out based on the taxpayer’s AGI.
New law. The 2012 Taxpayer Relief Act retroactively extends this provision for two years so that a taxpayer can deduct, as qualified residence interest, mortgage insurance premiums paid or accrued before Jan. 1, 2014.
State and Local Sales Tax Deduction Reinstated and Extended
Taxpayers who itemize deductions may elect to deduct state and local general sales and use taxes instead of state and local income taxes.
New law. The 2012 Taxpayer Relief Act retroactively extends this provision for two years so that itemizers can elect to deduct state and local sales and use taxes instead of state and local income taxes for tax years beginning before Jan. 1, 2014.
Liberalized Rules for Qualified Conservation Contributions Reinstated and Extended
A taxpayer’s aggregate qualified conservation contributions (i.e., contributions of appreciated real property for conservation purposes) are allowed up to the excess of 50% of the taxpayer’s contribution base over the amount of all other allowable charitable contributions (100% for qualified farmers and ranchers), with a 15-year carryover of such contributions in excess of the applicable limitation.
New law. The 2012 Taxpayer Relief Act retroactively extends for two years the 50% and 100% limitations on qualified conservation contributions of appreciated real property so that they apply to contributions made in tax years beginning before Jan. 1, 2014.
Above-the-Line Deduction for Higher Education Expenses Reinstated and Extended
A taxpayer may claim an above-the-line deduction for qualified tuition and related expenses for higher education paid by that taxpayer during the tax year, subject to applicable adjusted gross income (AGI) and dollar limits.
New law. The 2012 Taxpayer Relief Act retroactively extends the qualified tuition deduction for two years so that it can be claimed for tax years beginning before Jan. 1, 2014.
Nontaxable IRA Transfers to Eligible Charities Reinstated and Extended
Taxpayers who are age 70 1/2 or older can make tax-free distributions to a charity from an Individual Retirement Account (IRA) of up to $100,000 per year. These distributions aren’t subject to the charitable contribution percentage limits since they are neither included in gross income nor claimed as a deduction on the taxpayer’s return.
New law. The 2012 Taxpayer Relief Act retroactively extends this provision for two years so that it’s available for charitable IRA transfers made in tax years beginning before Jan. 1, 2014. The Act includes two elections to deal with the retroactive reinstatement of this provision:
(1) A taxpayer may elect to have a distribution made in January of 2013 be treated as if it were made on Dec. 31, 2012.
(2) A taxpayer may elect to treat any portion of a distribution from an IRA to the taxpayer during December of 2012 as a qualified charitable distribution, provided that (i) the portion is transferred in cash after the distribution to an eligible charitable organization before Feb. 1, 2013, and (ii) except for the fact that the distribution wasn’t originally transferred directly to the organization, the distribution otherwise meets Code Sec. 408(d)(8)’s requirements.
False Prisoner Tax Return Disclosure Rules Modified and Made Permanent
IRS is allowed to disclose to the head of the Federal Bureau of Prisons (Bureau) and the head of any state agency charged with the responsibility for prison administration (agency), return information for individuals incarcerated in federal prison or state prison whom IRS has determined may have filed or facilitated the filing of a false return. The disclosure is permitted to the extent that IRS determines that it is necessary to permit effective federal tax administration.
New law. The 2012 Taxpayer Relief Act expands the persons to whom false prisoner returns and return information can be disclosed to include officers and employees of the Bureau or agency, contractors responsible for operating a Federal or state prison on behalf of the Bureau or agency, and legal representatives of the Bureau, agency, responsible contractor, or prisoner. It also expands the authorized uses of the disclosed information to include administrative and judicial proceedings arising from various administrative actions. These provisions are made permanent by the 2012 Taxpayer Relief Act.
Transfer of Amounts in Applicable Retirement Plans to Designated Roth Accounts
New law. 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). Such a transfer will not be treated as violating Code Sec. 401(k)(2)(B)(i), Code Sec. 403(b)(7)(A)(i), Code Sec. 403(b)(11), or Code Sec. 457(d)(1)(A) .
Recovery Act Extenders
The 2012 Taxpayer Relief Act extends for five years the following items that were originally enacted as part of the American Recovery and Investment Tax Act of 2009 and that were slated to expired at the end of 2012:
… the American Opportunity tax credit, which permits eligible taxpayers to claim a credit equal to 100% of the first $2,000 of qualified tuition and related expenses, and 25% of the next $2,000 of qualified tuition and related expenses (for a maximum tax credit of $2,500 for the first four years of post-secondary education);
… eased rules for qualifying for the refundable child credit; and
… various earned income tax credit (EITC) changes relating to higher EITC amounts for eligible taxpayers with three or more children, and increases in threshold phaseout amounts for singles, surviving spouses, and heads of households.
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