2012 AMERICAN TAXPAYER RELIEF ACT – Part 1 Individual Income Tax Rates
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President Signs Eleventh-Hour Agreement To Avert Fiscal Cliff
The 2012 American Taxpayer Relief Act answers many questions and raises others, this is a comprehensive and complicated bill. This post is Part 1 of 3 this week as we take a closer look at a few of the key points in this new legislation. Please note that I will not be posting the complete text of the bill here, however a full copy can be provided to you upon request. For specific discussions on how these changes may impact you and your tax situation feel free to contact Paul Muret at (918) 301-1100.
The tax side of the “Fiscal Cliff” has been averted. The U.S. Senate overwhelmingly passed legislation to avert the so-called fiscal cliff on January 1, 2013 by a vote of 89 to 8, sending the American Taxpayer Relief Act of 2012 to the House, where it was similarly approved on January 1, 2013 by a vote of 257 to 167. The American Taxpayer Relief Act allows the Bush-era tax rates to sunset after 2012 for individuals with incomes over $400,000 and families with incomes over $450,000; permanently “patches” the alternative minimum tax (AMT); revives many now-expired tax extenders, including the research tax credit and the American Opportunity Tax Credit; and provides for a maximum estate tax of 40 percent with a $5 million exclusion. The bill also delays the mandatory across-the-board spending cuts known as sequestration. President Obama signed the bill into law on January 2, 2013.
Individuals with incomes above the $450,000/$400,000 thresholds will pay more in taxes in 2013 because of a higher 39.6 percent income tax rate and a 20 percent maximum capital gains tax. Nevertheless, all taxpayers will find less in their paychecks in 2013 because of what the American Taxpayer Relief Act did not include: the new law effectively raises taxes for all wage earners (and those self-employed) by not extending the 2012 payroll tax holiday that had reduced OASDI taxes from 6.2 percent to 4.2 percent on earned income up to the Social Security wage base ($113,700 for 2013).
The American Taxpayer Relief Act avoids draconian automatic sunset provisions that were scheduled to take effect after 2012 under the Bush-era tax cuts in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) (both as extended by subsequent legislation, including the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act). Without the American Taxpayer Relief Act, individual tax rates on all income groups would have increased, taxpayer-friendly treatment of capital gains and dividends would have completely disappeared, the child tax credit would have plummeted to $500, enhancements to education tax incentives would have ended, the federal estate tax would have reverted to a maximum rate of 55 percent, and many other popular but temporary incentives would no longer be available.
INDIVIDUAL INCOME TAX RATES
The American Taxpayer Relief Act of 2012 makes permanent for 2013 and beyond the lower Bush-era income tax rates for all, except for taxpayers with taxable income above $400,000 ($450,000 for married taxpayers, $425,000 for heads of households). Income above these levels will be taxed at a 39.6 percent rate.
The 10, 15, 25, 28 and 33 percent marginal rates remain the same after 2012, as does the 35 percent rate for income between the top of the 33 percent rate (projected to be at $398,350 for most taxpayers) and the $400,000/$450,000 threshold at which the 39.6 percent bracket now begins.
Individual marginal tax rates of 10, 15, 25, 28, 33, and 35 percent at the end of 2012, therefore, are now set going forward at the same 10, 15, 25, 28, 33, and 35 rates, but with an additional 39.6 percent rate carved out from the old 35 percent bracket range. The fiscal cliff agreement also uses the same $400,000/$450,000 taxable income threshold to apply a higher capital gains and dividend rate of 20 percent, up from 15 percent (see discussion, at “Capital Gains and Dividends,” below).
The bracket ranges for the extension of the 35 percent rate now cover only a relatively small sliver of what had constituted the upper-income range. As projected for annual inflation, the range of the 35 percent tax bracket for 2013 because of the Bush-era rate extensions begins at $398,350, for all individual brackets, except half ($199,175) for married taxpayers filing separately. The 35 percent income bracket ranges for 2013, therefore, are:
- ▪ $398,350 – $400,000 for single filers
- ▪ $398,350 – $425,000 for heads of household
- ▪ $398,350 – $450,000 for joint filers. surviving spouses
- ▪ $199,175 – $225,000 for married filing separately
Taxpayers who find themselves within the 39.6 percent marginal income tax bracket nevertheless also benefit from extension of all Bush-era rates below that level.
As with all tax bracket ranges, the new law directs that the $450,000/$400,000 beginning of the 39.6 percent bracket be adjusted for inflation after 2013 based upon the standard formula. Also relevant, however, the new law did not adopt recommendations that had been floated for several years that would lower the inflation-factor applied annually to all tax bracket ranges, thereby raising slightly more tax revenue each year.
Full sunset of the Bush-era tax rates would have replaced the 10, 15, 25, 28, 33 and 35 percent rates with the Clinton-era rate schedule of 15, 28, 31, 36, and 39.6 percent.
President Obama had initially proposed a $250,000/$200,000 threshold for higher rates. This proposal had been based upon a modified adjusted gross income (AGI) amount. The new law not only raises the dollar value but also simplifies that proposal by keying the $450,000/$400,000 threshold amounts to bottom-line taxable income.
Although these rates are now made “permanent,” nothing would stop Congress from reconsidering the entire tax rate structure again in the future, as part of overall tax reform or even earlier as debt ceiling negotiations get under way shortly.
Trusts and estates. The American Taxpayer Relief Act similarly retains the Bush-era tax rates for all bracket levels that apply to trusts and estates, except for the highest rate bracket. That top rate increases to 39.6 percent and, as confirmed by a Joint Committee on Taxation Legislation Counsel, applies to what was the entire 35-percent bracket range and, therefore, is projected to begin in 2013 for taxable income in excess of $11,950.
Marriage Penalty Relief
The American Taxpayer Relief Act extends all existing marriage penalty relief. Before EGTRRA, married couples experienced the so-called marriage penalty in several areas. EGTRRA gradually increased the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return. The 2010 Tax Relief Act extended EGTRRAs marriage penalty relief through 2012.
Without marriage penalty relief, the standard deduction for married couples would be 167 percent of the deduction for single individuals rather than 200 percent. For joint filers in 2013, that would have meant a drop of $1,950, from $12,200 to $10,150.
EGTRRA also gradually increased the size of the 15 percent income tax bracket for a married couple filing a joint return to twice the size of the corresponding rate bracket for an unmarried individual filing a single return. The 2010 Tax Relief Act extended this treatment through 2012 only. Without that relief, the top of the 15 percent rate bracket in 2013 for married taxpayers filing jointly would be set at a projected $60,550 rather than $72,500.