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Tax law changes may be felt for many individual practitioners

March 27, 2013

By J.R. Armstrong, CPA, and Jodi Permenter, CPA

By passing the American Taxpayer Relief Act of 2012 (ATRA) in the early hours of Jan. 1, 2013, Congress managed to avoid, or at least postpone, the imminent and oft-discussed “fiscal cliff.”

The act permanently codified many of the temporary provisions enacted under President George W. Bush. For the majority of Americans, the act has kept the status quo by avoiding automatic tax hikes to low and middle-class families that would have occurred had the temporary tax cuts been allowed to expire.

However, the ATRA constitutes the largest tax increase in almost two decades, and many high-income taxpayers will notice higher tax rates and fewer deductions as they file their 2013 tax returns.

Tax rates

The ATRA has not changed the lowest six income tax brackets for individuals, but has added a seventh tax bracket of 39.6 percent for married taxpayers earning in excess of $450,000 ($400,000 for single filers) beginning in 2013. The higher tax rate will be taken in addition to the 3.8 percent Medicare surtax imposed on the lesser of (1) net investment income or (2) income in excess of $250,000 ($200,000 for single filers) implemented by the Affordable Care Act.

The Maximum Capital Gains Tax rates and Qualified Dividend Tax rates will remain the same for taxpayers falling into one of the first six tax brackets. As in prior years, taxpayers in the 10 to 15 percent income tax brackets will have a 0 percent long-term capital gains rate, and taxpayers in the 25 to 35 percent brackets will pay a 15 percent long-term capital gains rate.

However, taxpayers falling into the new 39.6 percent tax bracket will see a rise in their capital gains rate. Capital gains for these high-income taxpayers will be increased to 20 percent beginning this year.

Alternative Minimum Tax

The Alternative Minimum Tax (AMT), instituted in 1969, targeted high-income taxpayers who were able to avoid paying taxes by taking advantage of tax deductions in the law. The act originally allowed a $45,000 AMT Exemption, which was high enough to avoid affecting the middle class. However, this exemption was not indexed for inflation and had to be changed by congressional action, by way of an AMT “patch.” Because the latest congressional patch expired Dec. 31, 2011, experts believed an additional 24 million taxpayers would be subject to AMT in 2012 without further action. Thankfully, the ATRA created a permanent fix to AMT instead of just another temporary patch, and the AMT exemption will now be increased along with the rate of inflation.

Pease and PEP

Pease Limitations and Personal Exemption Phase-outs (PEPs) reduce the amount of itemized and personal deductions high-income taxpayers can claim on their tax returns. Both were temporarily repealed in 2010, but, without any action on these items by ATRA, are scheduled to make a comeback in 2013.

Pease Limitations reduce the allowed itemized deductions for wealthy taxpayers. In 2013, taxpayers with income in excess of $300,000 ($250,000 for single filers) could see as much as a 20 percent reduction in the deductible amount allowed.

Personal Exemption Phase-outs are meant to reduce the personal deductions allowed for high-income taxpayers. Under ATRA, these taxpayers will experience a 2 percent reduction in their personal exemptions for every $2,500 of income they have more than $300,000 ($250,000 for single filers).

Expiration of the Payroll Tax Holiday

Although the ATRA extended many tax cuts, the Payroll Tax Holiday was not extended for 2013.

Employees enjoyed a 2 percent payroll tax rate cut for the past two years, dropping their Social Security Tax rate from 6.2 percent to 4.2 percent. Beginning in 2013, the rate reverted to 6.2 percent. For taxpayers earning more than $113,700 in wages, the 2013 Social Security wage cap, the increase will reduce their take-home pay by $190 each month. Also, taxpayers with wages in excess of $250,000 ($200,000 for single filers) will also be assessed an additional .9 percent Medicare surtax as a result of the Affordable Care Act.

Deductions

The deduction for student loan interest has been permanently extended, while deductions for mortgage insurance premiums, tuition and fees, and classroom expenses have been extended for two years. Also, the state sales tax deduction, which may be taken in lieu of the state income tax deduction, has been extended for two years.

Section 179 Depreciation Deduction limits were enhanced for 2012 and 2013. Section 179 depreciation allows businesses to deduct 100 percent of the purchase price of new assets up to the lesser of (1) $500,000 or (2) taxable income. Section 179 is reduced for businesses that had more than $2 million in capital acquisitions during the year.

Bonus depreciation was temporarily extended for another year, so businesses will continue to enjoy 50 percent bonus depreciation through Dec. 31, 2013. This bonus depreciation may be taken over and above the Section 179 limit.

Credits

The Child Tax Credit has been permanently extended, allowing a $1,000 partially refundable credit to parents with a child under age 17. The Child and Dependent Care Credit, a non-refundable credit of up to $6,000, was permanently extended for parents who pay for a nanny, day care, pre-school, or day camp for their child so that they can work or look for work. The Adoption Credit and Earned Income Tax Credit were also permanently extended without any changes. The American Opportunity Tax Credit, a dollar-for-dollar $2,500 credit available to full-time college students or their parents, was temporarily extended and will expire on Dec. 31, 2017, without further congressional action.

Filing deadlines

Although the ATRA has not changed the filing deadline for returns, the eleventh-hour legislation has left the IRS scrambling to comply with the changes. As a result, the IRS delayed the start of tax season. Most individuals with simple returns were able to file by Jan. 30, 2013.

However, individuals and businesses with more complicated returns, including those claiming education credits, residential energy credits, general business credits, or depreciation, are unable to file their return until late February or March.

How much will my taxes increase?

Although the ATRA avoided the catastrophic tax increases that would have occurred without congressional action, it is still the largest tax hike since 1994. This increased tax burden falls almost exclusively on America’s upper class. Taxpayers with less than $300,000 in Adjusted Gross Income (AGI) will notice only a modest increase in their total income tax liability, if they notice an increase at all. Taxpayers with AGI between $300,000 and $450,000 will certainly feel the ATRA’s effects and can estimate paying an additional $4,000 to $5,000 in 2013. Taxpayers with an AGI around $550,000 will owe approximately $10,000 to $12,000 in additional tax liability. It is important to consult with a tax adviser and adjust your estimated tax payments accordingly in order to avoid costly late-payment penalties and interest.

Looking forward

Despite the accomplishments of the American Taxpayer Relief Act of 2012, many other significant issues were not addressed. Congress failed to implement the $110 billion in spending cuts, often called sequestration, required by the Budget Control Act, opting instead to postpone the cuts until March in hopes that they will be able to pass a long-term deficit reduction package to replace the heavy-handed cuts. Additionally, Congress postponed raising the debt ceiling until May, and with politicians on both sides of party lines stating that they are not open to compromise, we can expect a long and heated debate before Congress reaches an agreement. It is clear additional changes are imminent as Congress addresses these issues.

Armstrong is a partner in the firm of May & Company, LLP. Permenter is a member of the professional staff of May & Company, LLP. The firm consults with optometrists in 30 states, assisting with their tax planning and preparation, QuickBooks support, and business planning. May & Company was established in 1922 and has offices in Louisiana, Mississippi, and Alabama. He can be reached at 601-636-4762 or by email at jarmstrong@maycpa.com.

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