EXECUTIVE SUMMARY American Taxpayer Relief Act of 2012

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1 TAX LEGISLATION January 2013 EXECUTIVE SUMMARY American Taxpayer Relief Act of 2012 Late in the night, on January 1, 2013, Congress completed work on the tax piece of the so-called fiscal cliff negotiations. Related mandatory Sequestration cuts and the Federal debt limit extension have a new deadline of February 28, The President signed the American Taxpayer Relief Act of 2012 on January 2, Overview Late on the afternoon of Monday, December 31, 2012, it seemed more likely than not that we were going over the fiscal cliff from a tax perspective. At best, we hoped for bare bones legislation to avoid the largest tax increase in history on all American taxpayers in The main focus was on the statutory expiration of the Bush tax cuts and an Alternative Minimum Tax ( AMT ) patch to keep 30 million middle income taxpayers from having to pay it. Instead, we got a fairly comprehensive bill which addressed the above items as well as many other tax provisions of concern to many individual and business taxpayers. First, the estate and gift tax was changed slightly and made permanent. Second, most of the Extenders, a list of approximately 150 different deductions and credits for individuals and businesses were extended temporarily through at least the end of Notable Surprises 2% Payroll Tax Holiday is not extended into 2013 For the last two years, American workers have enjoyed a payroll tax holiday in the form of a FICA tax reduction from the employee s share of 6.2% of taxable wages to 4.2% of taxable wages. In 2012, the 2% benefit applied up to the Social Security wage base limit of $110,100. Thus, the maximum savings in 2012 was $2,202. For an individual earning $50k ($50,000), the savings was $1,000. The employers share had always remained at 6.2%. Qualified Dividends continue to be taxed in tandem with Long Term Capital Gains at a maximum rate of 20% As more fully explained below, both long term capital gains and qualified dividends were taxed at a maximum rate of 15% in Absent this legislation, long term capital gains and qualified dividends would have been taxed at a maximum rate of 20% and 39.6%, respectively, in 2013 (note that none of the 2013 rates above include the potential 3.8% Obamacare Medicare tax on investment income commencing in 2013).

2 By not having qualified dividends revert to ordinary income tax rates, it preserves an extremely valuable tax incentive for exporters called the Interest Charge Domestic International Sales Corporation ( IC-DISC ). The AMT patch is in place for 2012 and also made permanent - The Alternative Minimum Tax ( AMT ) is a parallel tax computation on Federal Form It operates as a form of stealth tax as it only applies when it is computed to be higher than the regular tax. The patch is a permanent extension of an enhanced AMT exemption amount which had expired on December 31, It previously had been extended in one and two year increments for the last twenty years. Without the extension of the AMT patch, it was estimated that 30 million middle class taxpayers would have seen their Federal income tax increase on their soon-to-be-filed 2012 Federal Form 1040 s. We no longer have to be wondering every two years when Congress will get around to addressing it. Estate Tax Rate goes up but the Lifetime Exemption amount remains the same - For 2011 and 2012, the Estate tax has applied to taxable estates exceeding $5,000,000 ($10,000,000 lifetime exemption for married couples) at a maximum rate of 35%. The rate will now permanently be set at 40% with the same lifetime exemption amount as indexed for inflation ($5,120,000 for 2013). Had Congress taken no action on the Estate tax, it was scheduled to be reinstated on January 1, 2013 for taxable estates exceeding $1,000,000 ($2,000,000 lifetime exemption for married couples) at a maximum rate of 55%. Extension of the R&D credit and the ability to offset it against the AMT The R&D credit or Innovation credit applies to businesses developing new or improved products, manufacturing processes or software applications. It had expired as of December 31, It is now extended for both 2012 and Perhaps more importantly for eligible flow through businesses, it may now be applied against both the regular tax and the AMT at the individual tax level. Typically, the R&D credit has only been able to reduce the regular tax down to the level it equaled the AMT, thereby reducing its ability to generate current tax savings. Extension of enhanced write-offs on business acquisitions of fixed assets o Section 179 small business current year expensing limit is retained at $500K for 2012 and Absent legislation, the Section 179 limit was to be $125k and $25k in 2012 and 2013, respectively. o 50% bonus depreciation for the acquisition of new property is extended one more year into It had been scheduled to expire at the end of Extension of the Exclusion of Cancellation or Modification of Debt on a Principal Residence Taxpayers are typically subject to cancellation of debt ordinary income when their mortgage on a principal residence is either reduced or otherwise modified. An exclusion of up to $2,000,000 had expired at the end of It is now extended one more year into A new potential 401(k) benefit is available to help pay for the 2 month delay in the mandatory Sequestration cuts Under the new law, conversions to Roth IRA plans will be available to 401(k) plans and other employee retirement accounts. Previously, such conversions could only be done from traditional IRA accounts. Although the amount converted is subject to income tax, subsequent distributions from a Roth IRA are free of any tax or penalty. It appears that employer retirement plans would need to be changed to accommodate such a Roth conversion. Good luck for those who still like to prepare their Form 1040 by hand As noted below, there are now 3 major income threshold amounts to take into account when computing your Federal tax starting in 2013: 2

3 o Bush tax cuts expire for taxable income over $400k/$450k for single/married taxpayers maximum tax rate increases from 35% to 39.6%. o Long term capital gains and qualified dividends are taxed higher to the extent that taxable income exceeds the same $400k/$450k for single/married taxpayers maximum tax rate increases from 15% to 20%. o Personal tax exemptions begin to be phased out for adjusted gross income ( AGI ) over $250k/$300k for single/married taxpayers. o Itemized deductions also begin to be phased out for AGI over $250k/$300k for single/married taxpayers. o The new 3.8% Obamacare Medicare tax on investment income kicks in to the extent that AGI exceeds $200k/$250k for single/married taxpayers. o The increased.9% Obamacare Medicare tax on earned income also applies to the extent that AGI exceeds $200k/$250k for single/married taxpayers. Tax Legislation Details Individual income tax rates o The Bush tax cuts were preserved and made permanent for 99% of American taxpayers o Absent the extension of these Bush tax cuts, it was estimated that up to 40 million Americans would return to the tax rolls in o In 2012, the maximum Federal tax rate was 35%. o In 2013, the maximum tax rate increases permanently to 39.6% for single/married taxpayers with taxable income in excess of $400k/$450k. o The taxable income threshold will be indexed for inflation beginning in 2014 Other Bush tax cuts made permanent o $1,000 Child credit (not indexed for inflation) o Dependent care credits equal to $1,050 for one dependent or $2,100 for 2 or more dependents (not indexed for inflation and phases out at upper AGI levels) o $10,000 Adoption credit and $10,000 income exclusion for employer assistance (indexed for inflation but phases out at upper AGI levels) o Employer credit for child care facilities o $2,000 contribution limit for Coverdell education savings accounts o Direct deduction from AGI for student loan interest of $2,500 annually without a 5- year maximum limitation o Exclusion for employer-provided educational assistance (Maximum annual exclusion of $5,250) Long term capital gains and qualified dividends o In 2012, the maximum tax rate was 15% o In 2013, the maximum tax rate increases permanently to 20% to the extent that taxable income exceeds $400k/$450k for single/married taxpayers. o As an example, if a married couple has $50k of long term capital gains and taxable income is $475k, $25k of the long term capital gains will be taxed at 20% (equal to the extent taxable income exceeds the $450k threshold) and the remaining long term capital gains will be taxed at 15%. o The taxable income threshold will be indexed for inflation beginning in Phase-outs of personal exemptions and itemized deductions o Beginning in 2013, phase-outs of personal exemptions and itemized deductions will return for single/married taxpayers with AGI in excess of $250k/$300k. 3

4 o 2% of total personal exemptions are lost for each $2,500 of AGI above the income thresholds. o As an example, for a married couple, all of their personal exemptions disappear when AGI hits $425k ($125k above the $300k threshold) o The loss of itemized deductions equals 3% of the amount by which AGI exceeds the income thresholds. o As an example, assume a married couple with AGI of $600k and itemized deductions of $100k. $9k of itemized deductions would be lost since AGI was $300k over the income threshold ($300k x.03 = $9k). o In no event may a taxpayer ever lose more than 80% of total itemized deductions o In addition, itemized deductions for medical expenses, investment interest and certain casualty losses are not subject to the phase-out. o The taxable income threshold will be indexed for inflation beginning in The AMT Patch o In order to avoid 30 million middle income taxpayers from unintentionally being subject to an extra tax, the AMT Patch (in the form of an enhanced AMT exemption) is extended retroactively to 2012 and made permanent for 2013 and all future years. o The AMT causes an extra tax when it is computed to be higher than the regular Federal income tax. o Beginning in 2012, enhanced AMT exemption amounts of $50,600/$78,750 for single/married taxpayers apply to lessen the chance the AMT tax will exceed the regular tax for middle income taxpayers. o The AMT exemptions are phased out by an amount equal to 25% of the amount that AMT income exceeds $112,500/$150,000 for single/married taxpayers. o For 2012 and 2013, all nonrefundable credits may reduce the AMT including the R&D credit, the Rehabilitation credit and certain energy credits. o The AMT exemption threshold will be indexed for inflation beginning in Estate and Gift tax rates o Beginning in 2013, the unified estate and gift tax rates are made permanent and increased from 35% to 40%. o The individual Lifetime exemption remains at $5,120,000, the same as in 2012 ($10,240,000 for a married couple). o In other words, an individual can either gift during their lifetime or transfer assets at death in an amount equal to $5,120,000 before any estate or gift transfer tax applies. However, the first dollar over the lifetime exemption will be taxed at 40% immediately. o The same rates and exemption apply to the Generation Skipping Tax ( GST ). o Portability of lifetime exemptions is retained between married spouses, regardless of which spouse actually owns specific assets. In fact, a surviving spouse can file an election to retain the use of any unutilized lifetime exemption of the first spouse to die. o Annual gift exclusions are unaffected by the new legislation. Such amounts are $13k and $14k per recipient in 2012 and 2013, respectively. o The deduction for state death tax is permanently extended. o The lifetime exemption will be indexed for inflation beginning in

5 The Extenders various individual and business deductions and credits extended in most cases for both 2012 and 2013 o The provisions extended: Federal R&D credit or innovation credit State sales tax deductions for taxpayers in states like Florida with no state income tax Empowerment Zone wage credit for employees who both live and work in a designated zone (Jacksonville has several larger areas designated as Federal Empowerment Zones). For C corporations converting to S corporations, the 10 year built-in gain period is reduced to 5 years for dispositions through the end of Direct deduction from AGI for qualified tuition and expenses Tax free IRA contribution to charity of up to $100k for taxpayers over age 70½ Deduction for mortgage insurance premiums New Markets tax credit Work Opportunity tax credit Employer wage credit for active-duty military employees 15 year straight line cost recovery for qualified leasehold improvements and qualified restaurant and retail property improvements Ethanol and Biofuel tax credits Incentives for Biodiesel and renewable diesel Alternative fuel vehicle refueling property credit Section 199 deduction for Puerto Rican production activities Enhanced deductions for business fixed asset additions o Section 179 small business current year expensing applies to any acquisitions of new or used equipment. However, it is subject to a phase-out once total acquisitions exceed a set amount. o The Section 179 small business current year expensing limit is reinstated at $500k for 2012 and In each year, the Section 179 limit is reduced dollar for dollar by the amount by which total fixed assets exceed $2,000,000. Thus, if a business acquires $2,500,000 in fixed assets in either year, the potential $500k Section 179 current year write-off is completely phased out for that year. o Section 179 must be elected by a taxpayer but can never reduce the taxable income for a business below zero. Any Section 179 deduction which is unused due to the taxable income limitation may be carried forward to future tax years in which there is sufficient taxable income. o Absent this legislation, the Section 179 deduction limit was to be $125k and $25k in 2012 and 2013, respectively. o 50% Bonus depreciation for the acquisition of new property is extended one more year into It had been scheduled to expire at the end of o New property means the first use of equipment, not that it is new to you. o Bonus depreciation is mandatory unless a taxpayer elects out. o Bonus depreciation may create a taxable loss for a business. Such net operating loss may either be carried back 2 years or carried forward 20 years (again by election) o Both Section 179 deductions and bonus depreciation deductions apply to assets with a MACRS depreciable life of 20 years or less. 5

6 Future Timetable What is permanent (or as permanent as anything gets these days with Congress)? o Federal income tax rates for all American taxpayers for 2013 and all future years o Maximum tax rate on long term capital gains and qualified dividends for 2013 and all future years o The AMT patch for 2012 and all future years o The end of the 2% payroll tax holiday after 2012 o Estate and Gift tax rates and lifetime exemptions for 2013 and all future years o 3.8% Obamacare Medicare tax on certain investment income for 2013 and all future years o.9% Obamacare Medicare tax on certain earned income for 2013 and all future years What needs to be resolved before February 28, 2013? o Mandatory Sequestration budget cuts As an example, under Sequestration as it stands today, the IRS would take an 8.2% budget cut on March 1, 2013 and would most likely have to furlough workers o Federal debt ceiling What needs to be resolved before December 31, 2013? o The fate of the most notable extenders R&D or Innovation credit State sales tax deduction Empowerment Zone credits o The fate of Section 179 small business current year expensing limit o The fate of 50% bonus depreciation for new fixed asset additions o The fate of the exclusion for cancellation of debt arising from principal residence mortgage reductions or modifications What needs to be indexed for inflation in 2014 and future tax years? o $400k/$450k income threshold for maximum 39.6% Federal tax bracket o $400k/$450k income threshold for maximum 20% tax rate on long term capital gains and qualified dividends o AMT patch exemption amounts ($50,600/$78,750 for single/married taxpayers in 2013) o Estate and Gift unified lifetime exemption amount ($5,120,000 in 2013) What is not indexed for inflation in future tax years? o $200k/$250k income threshold for the 3.8% Obamacare Medicare tax on investment income o $200k/$250k income threshold for the.9% Obamacare Medicare tax on earned income 6

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