In the early hours of 2013, Congress passed, and the President signed, the American Taxpayer Relief Act of 2012 (the “2012 Tax Act”), leaving most of our clients asking the question, how does the 2012 Tax Act impact my income and/or estate tax planning?
Estate and Gift Tax Provisions
For the first time in many years, in the area of estate and gift tax planning, we have permanent legislation. The provisions of the 2012 Tax Act do not contain any temporary or sun-setting provisions, and therefore unlike the past several years, these provisions will remain intact unless Congress and the President approve additional legislation.
- Lifetime Exclusion Amounts. The 2012 Act maintains the $5,000,000.00 exclusion amounts instituted in 2010 for gift, estate and generation-skipping taxes, indexed for inflation. As a result of inflation, this amount was increased in 2012 to $5,120,000.00, and is further increased in 2013 to $5,250,000.00.
- Tax Rates. The tax rate has been increased from 35% to a maximum tax rate of 40% on estate and gift transfers that exceed the exclusion amounts.
- Portability. The concept of “portability,” i.e., a surviving spouse’s ability to use the unused exclusion amounts of a predeceased spouse, is now permanent. A couple of important items to note regarding portability include: (i) an election to allow the surviving spouse to use portability must be made upon the death of the first spouse via an IRS Form 706, Estate Tax Return, regardless of whether the first spouse had a taxable estate at death; and (ii) portability does not apply to generation-skipping tax exclusion amounts, those cannot be used by the surviving spouse.
Income Tax Provisions
- Much of the debate regarding the 2012 Tax Act, as well as the provisions of the 2012 Tax Act, relate to the income tax provisions, which include:
- Ordinary Income Tax Rates. The income tax rates on ordinary income and short-term capital gains for those with taxable income of less than $400,000.00 for individuals and $450,000.00 for married couples (“High Income Taxpayers”), will remain at current income tax rates. The maximum income tax rate for High Income Taxpayers will increase to 39.6%. The 3.8% Medicare Tax, an additional tax on investment income for taxpayers with earnings in excess of $200,000.00 for individuals and $250,000.00 for married couples, is still in place. To the extent that ordinary income or short-term capital gains are from “investment income,” there will be an additional Medicare tax of 3.8%, potentially increasing the maximum tax rate for some taxpayers to 43.4% on investment income
- Capital Gains Rates. The long-term capital gains rates for taxpayers will remain the same, with the exception of High Income Taxpayers, who will now have a tax rate of 20% on long-term capital gains. However, this tax rate is graduated, meaning, if a taxpayer’s income without the long-term capital gains is less than the threshold ($400,000.00/$450,000.00) the portion of the long-term capital gain that is less than the threshold will be taxed at 15% and the portion that exceeds the threshold will be taxed at 20%. In addition, to the capital gains rate, the 3.8% Medicare Tax may apply if the threshold is satisfied, increasing the maximum rate on long-term capital gains to 23.8%.
- Qualified Dividends. The 2012 Tax Act permanently continues the treatment of qualified dividends at long-term capital gains rates. Therefore, dividends may range from 15% to 23.8% depending upon a taxpayer’s total income.
- Payroll Tax Reductions End. For the past two years, we have experienced a reduction in FICA withholding on wages from 6.2% to 4.2% on approximately the first $100,000.00 in earnings. This tax reduction ended on December 31, 2012 and was not extended under the 2012 Tax Act. In addition, there is an additional Medicare Tax of 0.9% that commenced on January 1, 2013 for those exceeding the Medicare Tax threshold (i.e., taxpayers with earnings in excess of $200,000.00 for individuals and $250,000.00 for married couples).
- Phase Out of Itemized Deductions. In addition to increases in the income tax rates, itemized deductions, other than medical expenses, interest expenses and casualty losses, will be phased out once a taxpayer’s AGI exceeds the thresholds (i.e., $250,000.00 for individuals and $300,000.00 for married couples), up to a total 80% reduction in itemized deductions. In addition, the threshold deducting medical expenses as an itemized deduction has been increased to 10% for most taxpayers.
Charitable Deductions – Ability to Use IRA Contributions
The 2012 Tax Act once again provides the ability to make charitable contributions using your IRA distributions up to $100,000.00 for taxpayers over the age of 70½ and subject to required minimum distributions. For 2012, taxpayers may contribute an IRA distribution to a 501(c)(3) organization prior to February 1, 2013, to take advantage of the 2012 benefits from IRA proceeds. Thereafter, an additional $100,000.00 may be contributed prior to December 31, 2013 from IRA proceeds for the 2013 tax year.
If you would like any assistance in navigating the 2012 Tax Act, or have specific questions, please feel free to contact us at Blalock Walters, P.A. Have a prosperous year!