President Signs American Taxpayer Relief Act of 2012

On January 2, 2013, the President signed into law the American Taxpayer Relief Act of 2012 (“ATRA”) that prevents broad federal tax increases and spending cuts from going into effect beginning January 1, 2013. Thus, at least for the time being, the so-called “fiscal cliff” has been avoided.

The new law retains many of the favorable tax measures that were slated to expire at the end of 2012. However, ATRA increases federal income taxes for certain higher income taxpayers, as well as federal transfer taxes (estate taxes, for example) for high net worth individuals. Here is a brief summary of some of the new law’s major provisions.

Individual Income Tax Rates. Generally, rates remain at 10%, 15%, 25%, 28%, 33%, and 35%, instead of increasing to 15%, 28%, 31%, 36%, and 39.6%, as would have been the case absent enactment of the new law. Starting in 2013, however, higher-income taxpayers (single filers with taxable income of more than $400,000; joint filers with income of more than $450,000; and heads of households with income of more than $425,000) will pay a top marginal tax rate of 39.6% (as opposed to 35%).

Capital Gains and Dividend Tax Rates. For tax years beginning after 2012, the top rate for capital gains and dividends will permanently rise to 20% (up from 15%) for higher income taxpayers. Coupled with the 3.8% surtax on investment-type income, the top overall rate will be 23.8%. Taxpayers whose highest ordinary income-tax bracket is less than 25% will generally be taxed at a 0% rate. Individuals who are subject to a 25% ordinary tax bracket or higher — but who fall below the top 39.6% bracket — will continue to be taxed at the 15% rate for dividends and capital gains.

Alternative Minimum Tax. Higher AMT exemption amounts (the “AMT patch”) that expired after 2011 are reinstated for 2012 and have been made permanent. For 2012, the AMT exemption amounts are $50,600 for unmarried individuals, and $78,750 for joint filers, to be indexed for inflation after 2012. Absent the legislation, AMT exemption amounts would have been $33,750 and $45,000.

Limit on Itemized Deductions. The limitation on itemized deductions, which expired after 2010, is reinstated for higher income individuals ($300,000 of adjusted gross income for joint filers; $250,000 of AGI for singles). The maximum itemized-deduction reduction may not exceed 80%.

Reduction of Personal Exemptions. ATRA revives the personal exemption phase-out rules. Generally, under the phase-out, the total value of exemptions that may be claimed by a taxpayer is reduced by 2% for each $2,500 by which the taxpayer’s AGI exceeds the applicable threshold amount. The reduction starts at the same income levels as the phase-out of itemized deductions explained above.

Other Individual Extenders. Many individual tax provisions — such as the deduction for teachers’ classroom expenses and the ability of individuals age 70½ or older to take up to $100,000 a year of tax-free distributions from Individual Retirement Accounts and donate them to public charities — have been retroactively extended through 2013. Furthermore, a five-year extension applies to The American Opportunity Tax Credit, which generally permits eligible taxpayers to claim a credit equal to 100% of the first $2,000 of qualified college tuition expenses, and the earned income tax credit. And the new law extends the $1,000 child tax credit permanently.

Estate and Other Transfer Taxes. The top gift, estate, and generation skipping transfer tax rate is increased from 35% to 40%. There is a $5 million exemption (subject to an inflation adjustment) for individuals dying and gifts made after 2012.

Social Security Taxes. What wasn’t included in the law is notable. For example, the two percentage-point reduction in the employee portion of the Social Security payroll tax was allowed to expire after 2012.

Section 179 Small Business Expensing. ATRA increases, retroactive to tax years beginning in 2012, the maximum expensing amount from $139,000 to $500,000. For tax years beginning in 2013, the new law increases the maximum expensing amount from $25,000 to $500,000. The investment-based phase-out amount is also increased under the Act, to $2,000,000, for tax years beginning in 2012 or 2013.

Bonus Depreciation. ATRA generally extends the 50% first year bonus depreciation by applying it to qualified property acquired and placed in service before January 1, 2014.

Business Extenders. Certain tax credits for businesses, such as the Research Credit and the Domestic Production Activities deduction, are generally extended through the end of 2013.