Published:

02/02/2013 11:01am

Last-Minute Fiscal Cliff Tax Deal Reached - Highlights of the American Taxpayer Relief Act of 2012

January 7, 2013

The United States plunged off the theoretical cliff New Year's Day, but the U.S. House of Representatives pulled us back by passing the U.S. Senate's version of the budget bill on New Year's Day, and lo and behold, we now have clarity on tax rates and tax provisions for 2013 and beyond. While vacationing with his family in Hawaii, President Obama's signature was put on the legislation officially known as the "American Taxpayer Relief Act of 2012" (the Act) on January 2, 2013, by an autopen signing machine in Washington. In the most simplest terms, the legislation:

•Averts the tax side of the fiscal cliff, but simply delays sequestration (the automatic spending cuts) side by two months;
•Raises income taxes on individuals with income over $400,000 a year and families with income over $450,000 by more than 13% from a maximum rate of 35% to 39.6%;
•Raises capital gains and qualified dividend taxes on individuals with income over these levels by 33% from 15% to 20% (Incidentally, the 28% and 25% tax rates for collectibles and Section 1250 gain, respectively, continue without change after 2012);
•Imposes a stiff marriage penalty on couples, as married couples filing jointly with combined incomes of $450,000 are subject to the 39.6% rate instead of double the single threshold, or $800,000;
•Maintains the lower Bush-era ordinary tax at a maximum rate of 35% and capital gains and qualified dividend tax at a maximum rate of 15% for those not reaching these same income levels. However, taxes will be effectively raised on individuals earning more than $250,000 a year and families making more than $300,000 by limiting the previously suspended Personal Exemption Phase-out (PEP) and the previously suspended limitation on itemized deductions;
•Raises taxes for all wage-earners (and those self-employed) by not extending the 2% Social Security tax reduction;
•Permanently patches the Alternative Minimum Tax (AMT) so that more than 30 million taxpayers avoid this secretive and steep tax;
•Permanently extended the child and dependent care credit;
•Permanently raises the maximum federal estate tax rate on estates valued at $5 million for individuals and $10 million for couples, indexed for inflation, from 35% to 40%, unifies the estate and gift tax and maintains "portability" between spouses; and
•Retains many favorable tax breaks that were scheduled to expire, including but not limited to, tax-free distributions to charity from individual retirement plans (including IRAs) in 2012–2013, the Work Opportunity Tax Credit, the Section 179 deduction, tuition and fees expense deduction, and the exclusion of gain on the sale of small business stock, all of which are described in much greater detail below.

These tax changes are in addition to the new Medicare surtaxes. Beginning this year, the Patient Protection and Affordable Care Act imposes a 3.8% surtax on unearned income (e.g., passive income of individuals, trusts and estates) and a .9% tax on earned income (e.g., wages and self-employment income) in addition to current Social Security and Medicare taxes. The amount subject to the 3.8% tax is the lesser of net investment income or the excess of the taxpayers' modified adjusted gross income over $250,000 for taxpayers married filing jointly, $125,000 for married taxpayers filing separately and $200,000 for all other individual taxpayers.

The following chart presents a quick summary of pre- and post-Act tax rates for "high income taxpayers" (generally defined as single taxpayers with income in excess of $400,000 and married taxpayers filing jointly with income in excess of $450,000 and head-of-household taxpayers with incomes in excess of $425,000).

*The New Medicare Hospital Insurance Tax and the New Net Investment Income Tax on Unearned Income applies to income in excess of $200,000 for single taxpayers and $250,000 for married taxpayers filing jointly. For taxpayers subject to the net investment income tax, the effective rate of tax will be 23.8%.

The following chart presen