The Tax Implications of the American Taxpayer Relief Act (ATRA)

By Rick Cooley, CPA

It wasn’t pretty. It was a tough, brutal battle. We’re not talking about the playoff game between Seattle and Atlanta. We’re talking about the battle on the Beltway – the one dealing with the fiscal cliff — the passing of the American Taxpayer Relief Act (ATRA.)

Now that legislation has been passed and signed to address the tax side of the fiscal cliff, here’s a play-by-play of what you can expect.

The Impact on Upper Income Taxpayers

The main impact of the ATRA is the permanent extension of the so-called Bush tax rates for individuals with income up to $400,000, families up to $450,000. Above these income levels, the ATRA imposes a new 39.6% income tax rate.

The ATRA also imposes a new 20% (up from 15%) tax rate on long-term capital gains and dividends, again for individuals making over $400,000 and families making over $450,000. Thus the feared increase in the dividend tax rate from 15% in 2012 to 39.6% has been avoided. However, the Medicare surtax of 3.8% will still apply to most capital gain income, for taxpayers with incomes above $250,000. The old 15% dividend and long-term capital gain rate from 2012 and prior years will continue to apply to taxpayers with incomes below these thresholds.

The Impact on Business Taxpayers

A number of popular business deductions and credits are retroactively extended by ATRA, but only through 2013:

• Research and development tax credit.
• Enhanced $500,000 Section 179 business asset expense election.
• 50% “bonus” depreciation.
• Accelerated depreciation for qualified leaseholds, retail and restaurant improvements.
• The Work Opportunity Tax Credit.
• The impact on individual taxpayers.

Some popular individual tax deductions and credits are also extended retroactively by the ATRA, but just though 2013:

• Non-business energy credit.
• IRA direct-to-charity distributions of up to $100,000 for qualified taxpayers over 70 ½ years of age. An election to allow January 2013 distributions to be treated as 2012 qualifying distributions is included.
• Sales tax deduction.
• Limited extension of the 100% gain exclusion on qualified small business stock.
• Discharge of qualified principal residence indebtedness exclusion is extended for one more year.
• Deduction for charitable donation of conservation easements.

In addition, the $1000 child tax credit that was scheduled to revert to $500 as of 1/1/2013, has been made permanent.

Lastly, a number of education incentives, such as Coverdell savings accounts enhancements and the American Opportunity tax credit, were either made permanent or were at least temporarily extended.

Alternative Minimum Tax (AMT) Patch is Made Permanent

Perhaps one of the most beneficial changes included in the ATRA is that the AMT patch finally is made permanent. This will avoid the AMT penalizing an additional 30 million taxpayers and will avoid the annual drama of Congress having to fix the AMT with a temporary patch. This permanent fix will provide most middle-income taxpayers with some certainty in planning for the AMT.

Limitations on Itemized Deductions and Personal Exemptions for Individual Taxpayers is Back

The ATRA revives the old itemized deduction limitation on high income taxpayers along with the phase-out of personal tax exemptions. These phase-outs temporarily went away for 2011 and 2012.

The threshold for the phase-out of these tax deductions for 2013, adjusted for inflation, is $250,000 for unmarried taxpayers and $300,000 for married couples filing a joint tax return. The maximum phase-out on itemized deductions is 80% of total itemized deductions, as in prior years.

Some deductions are not subject to the phase-out: investment interest expense, medical expenses and casualty or wagering losses are subject to separate and independent limitations. As in prior years, the personal exemptions may be completely eliminated if the taxpayer’s income is high enough.

Payroll Tax Holiday is not Extended

One benefit that was not extended was the 2% temporary FICA payroll tax reduction on employee wages. The impact of this expiration is a payroll tax increase on approximately 67 million American taxpayers, but a further extension was considered too costly.

Estate and Gift Tax Rate has Changed

On the federal estate and gift tax side, the ATRA raises the top federal estate and gift tax rate from 35% to 40%. However, the $5 million estate and gift tax exemptions, indexed to $5.12 million for 2012, is permanently extended on an integrated basis, meaning the $5 million exemption applies equally to lifetime gifts as it does to estates. The exemption is indexed for inflation.

Fiscal Cliff Part II: Debt Ceiling, Sequestration and Tax Reform Battles Yet to Come

Congress and the President were unable to reach agreement on two critical issues: increasing the debt ceiling and spending cuts. Sequestration, or mandatory spending cuts, was deferred for two months to allow time for Congress to address these difficult and contentious issues. Both the President and the Congress appear to feel that they have the upper hand in the upcoming battle over the debt ceiling and sequestration. Expect this next round of negotiations to be as dramatic as the ones just past. It seems likely that the Congress and the President will again reach a compromise on sequestration and debt ceiling at the last minute, but it will be another struggle in deeply divided Washington, DC.

What has been lost in the fiscal cliff shuffle has been the pursuit of meaningful tax reform. Comprehensive tax reform will likely be postponed again during the sequestration and debt ceiling negotiations. However, expect this to be a recurring issue in the 113th Congress. Both the Congress and the President have supported comprehensive tax reform for both individuals and businesses.

© Clark Nuber PS, 2013.  All Rights Reserved