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President Obama signed into law the American Taxpayer Relief Act (H.R. 8) late Jan. 2, permanently extending the 2001 and 2003 tax cuts for individuals earning up to $400,000 and postponing automatic, across-the-board spending cuts for two months.
The Act also permanently indexes the alternative minimum tax exemption amount to inflation, extends emergency unemployment benefits for one year, and continues current Medicare payment rates to doctors for one year.
With the prospect of a spike in milk prices also coming in 2013 because of a scheduled jump in federal subsidies to dairy producers, lawmakers opted to include an extension of farm bill policies and programs through the end of the fiscal year. The Act was the result of last-minute negotiations between Vice President Joe Biden and Senate Minority Leader Mitch McConnell (R-Ky.) to avoid the fiscal cliff.
Other major changes included permanently raising the top capital gains and dividends tax rates to 20% on household income in excess of $450,000, while keeping the 15% rate intact for those earning less.
On top of those provisions, the Act also sets the estate and gift tax rate at 40%--up from 35% in 2012--and permanently indexed the $5.12 million per person exemption level to inflation.
Estate tax advisers and attorneys issued a collective sigh of relief Jan. 2 in reaction to the passage of the provisions.
“The two big things that people were worried about did not come to pass,” Beth Kaufman, an attorney with Caplin & Drysdale, told BNA Jan. 2. The estate and gift taxes remain unified, and because the exemption level is not going down, clawback has ceased to be an issue.
For 2013, according to IRS inflation factors, the exemption is estimated to be $5.25 million, according to Richard Behrendt, senior vice president with Baird in Milwaukee. If inflation were to rise to 3%, the exemption could become almost $6.5 million by 2020, said Behrendt. Inflation is currently 1.8%.
All the provisions from 2012 were extended with the exception of the rates, which means portability of the estate tax and gift tax was also extended. Under the portability rules, a spouse is allowed to use the unused estate and gift tax exemption amounts of a deceased spouse.
Perhaps the biggest windfall was the permanency of the provisions. A permanent estate tax has been lacking for more than a decade so the fact that wealth planners will now know what they are dealing with from year to year is the biggest bonus, most said.
There is also no restriction on grantor retained annuity trusts or the use of valuation discounts.
The big bonanza in gift-giving most likely occurred in 2012, as affluent taxpayers rushed to take advantage of what they thought would be a fleeting $1 million gift exemption, Kaufman said. But there are still good reasons to make gifts. Not everyone got it done in 2012, and there is always the lure of getting the future appreciation of the assets out of the estate.
A separate provision would curb the impact of the reinstatement of the personal exemption phase-out and the limitation on itemized deductions under the Pease limitation, named after former Rep. Donald Pease (D-Ohio). The phase-out and limitation will begin at $250,000 for individuals and $300,000 for joint filers.
Short-term changes in the law include an extension of $76 billion in temporary tax incentives through 2013. The package includes many popular tax provisions, such as the research and development tax credit, the tax deduction for state and local sales taxes, and an above-the-line deduction of up to $250 for teachers using their own money to buy classroom supplies.
With a new 3.8% surtax on investment income becoming effective in 2013 for individual income in excess of $200,000 ($250,000 for joint filers), there will now be three different thresholds at which high-income households could be impacted by tax increases.
In a report outlining the changes to the law, Deloitte Tax said the legislation reduces some of the uncertainty about future tax rates, but in some ways the changes can be seen as adding complexity to the tax code.
Deloitte noted that long-term capital gains from the sale of a typical appreciated stock will now potentially be subject to four different tax rates, ranging from zero to 23.8% with the inclusion of the new surtax.
“This range of tax rates does not take into consideration other types of capital gains transactions that have unique rates, for example, unrecaptured [tax code] §1250 gain and collectibles taxed at 25% and 28%, respectively. It is little better for ordinary income,” the Deloitte report said.
In addition, Deloitte reminded its clients that individuals with income in excess of $400,000 will face the new 39.6% tax bracket, but those earning from $200,000 ($250,000 for couples) to $400,000 would still need to take into account the additional 0.9% Medicare Hospital Insurance tax that was put into law under the Affordable Care Act and also goes into effect in 2013.
“And of course for both ordinary and investment income there will be the application of 'stacking rules' to determine which income is taxed at the lower rates and which at the higher. Thus, while taxpayers may cheer the fact the Act makes permanent many unsettled areas of law, the added complexity it creates will no doubt also drive calls for Congress to consider fundamental tax reform sooner rather than later,” the report said.
Congress extended indefinitely several tax provisions impacting employer-provided fringe benefits, including adoption assistance and education assistance.
The Act also reestablished parity between mass transit and parking fringe benefits, extending the parity until Jan. 1, 2014, according to the Act. The provision applies to months after Dec. 31, 2011, the Act said.
A special rule that would expand eligibility for in-plan Roth transfers caught benefit practitioners by surprise when they learned it was included in legislation addressing the fiscal cliff, but some practitioners said the tax provision would improve existing retirement policy.
“It was a bit of a surprise, but at the same time, it's good policy,” David C. John, senior research fellow in retirement security and financial institutions at the Heritage Foundation, told BNA Jan. 2.
If individuals decide “that it's to their benefit to switch to a Roth [account] within a plan, this enables them to do it, and they don't have to wait for a specific instance or an artificial age limitation,” he said.
The Act amends §402A(c)(4) by adding a special rule for Roth transfers. The new rule permits more participants in qualified retirement plans with in-plan Roth conversion features to transfer amounts to Roth accounts.
The special Roth rule in the fiscal cliff legislation would generate an estimated $12.2 billion within a 10-year budget window.
“It's small potatoes in terms of its [revenue] impact, but the fact that things can be done so cavalierly with the retirement system, which really deserves more serious attention than it gets, is sort of discouraging,” Alicia H. Munnell, director of the Center for Retirement Research and professor of management sciences at Boston College, told BNA Jan. 2.
“I don't think anybody cared whether it was good benefit policy or not,” Munnell added. “I'm for making things easy and automatic, so giving people one more option is not necessarily helpful,” she said.
The legislation also extends the wind production tax credit and several other energy-related tax incentives for alternative power, biofuels, and energy efficiency.
The American Taxpayer Relief Act includes more than $18.1 billion to extend existing energy tax incentives over a 10-year period. The largest item, estimated to cost $12.2 billion, would be an extension of a production tax credit for wind and other forms of renewable energy, according to Joint Committee on Taxation estimates.
The modification to the wind production tax credit, which was included in a tax extenders bill (S. 3521) approved by the Senate Finance Committee in August, establishes a “de facto extension” lasting two-and-a-half years or more, according to a research note published Jan. 2 by ClearView Energy Partners, a consulting firm.
However, ClearView said “the generous expansion of the PTC could represent a 'sunset' ” for the tax credit as Congress considers future tax reform, despite a proposal by the wind energy industry to phase the credit out over a six-year period.
The American Wind Energy Association, the industry's main trade group, hailed the extension of the PTC, saying in a Jan. 1 statement it would save as many as 37,000 jobs in the wind industry and revive business at nearly 500 manufacturing facilities across the country.
By Brett Ferguson and Cheryl Bolen
The Deloitte Tax report, Swerving from the cliff: Tax provisions in the American Taxpayer Relief Act of 2012, is at http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/Tax/us_tax_swerving_from_the_cliff_010213.pdf.
For an analysis of the American Taxpayer Relief Act by the Tax Management staff, see the Tax Legislation section of this issue.
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