US Congress Spends New Year's Eve and New Year's Day Negotiating, Debating, and Passing Extension Package
Host of Provisions are Extended, But Most US Taxpayers Will Still Encounter Higher Taxes in 2013 Due to Expiration of Payroll Tax Reduction and New Taxes not Addressed by Extension Package
On December 31, 2012, a host of tax and spending provisions were scheduled to expire. On January 2, 2013, substantial cuts to defense programs and to domestic discretionary spending also were scheduled to commence. Negotiations in Washington regarding these provisions had been taking place for weeks without resolution, with a sequence of different negotiating partners seeking, and failing, to reach agreement. Finally, on New Year's Eve, Senate Minority Leader McConnell and Vice President Biden were able to work out a compromise package, and in an unusual New Year's Eve session that stretched well into New Year's Day, the Senate overwhelmingly passed the package. In an even more unusual New Year's Day session, the House of Representatives passed the Senate package unchanged, with House Democrats voting overwhelmingly for it while a majority of House Republicans voted against it. The package, entitled the "American Taxpayer Relief Act of 2012," now goes to the President who has stated that he will sign the bill.
Highlights of the American Taxpayer Relief Act (the "Act") include
I. Permanent extension of the 2001 and 2003 ("Bush") tax cuts, at least for taxpayers with incomes below certain thresholds
- Basic Tax Rate Structure. The 10/15/25/28/33/35 individual income tax rate structure was permanently extended for taxpayers with taxable incomes not exceeding $400,000 ($425,000 if head of household and $450,000 if married filing jointly). Incomes above the $400,000+ thresholds will be subject to a 39.6% rate. Thus, with the new 0.9% additional Medicare tax on wages and self-employment income and the new 3.8% Medicare tax on net investment income, the top tax rate for upper-income taxpayers will be 43.4%, which will not only be a higher tax rate than the tax rate in 2012 but also will be a higher tax rate than the tax rate under pre-2001 law.
- Capital Gains. The 0/15 long-term capital gains tax rate structure was permanently extended for taxpayers with taxable incomes not exceeding $400,000 ($425,000 if head of household and $450,000 if married filing jointly). Incomes above the $400,000+ thresholds will be subject to a top capital gains tax rate of 20%. Thus, with the new 3.8% Medicare tax on net investment income, the top tax rate on capital gains will be 23.8% (up from 15% in 2012 and 20% in 2000).
- Dividends. Qualified dividends continue to be taxed like capital gains. Thus, the 0/15 qualified dividend tax rate structure was permanently extended for taxpayers with taxable incomes not exceeding $400,000 ($425,000 if head of household and $450,000 if married filing jointly). Incomes above the $400,000+ thresholds will be subject to a top tax rate of 20% on qualified dividends. Thus, with the new 3.8% Medicare tax on net investment income, the top tax rate on qualified dividends will be 23.8% (up from 15% in 2012 and 20% in 2000).
- Estate tax. The estate and gift tax rules applicable in 2012 (including the $5 million exemption equivalent and the unified exemption amount with portability) were made permanent, except the top rate increases to 40% (up from 2012 rate of 35%).
- Return of limitation on itemized deductions and personal exemption phase-out. Before being suspended in 2010, an overall limitation on itemized deductions applied to upper-income taxpayers, reducing the total amount of itemized deductions that could be claimed by a taxpayer as the taxpayer's adjusted gross income exceeded certain income levels. Similarly, before being suspended in 2010, personal exemptions were gradually reduced and phased-out as a taxpayer's adjusted gross income exceeded certain income levels. The Act ends the suspension of these two provisions for taxpayers with adjusted gross incomes exceeding $250,000 ($275,000 if head of household and $300,000 if married filing jointly), thereby causing those taxpayers to become subject once again to the overall limitation on itemized deductions and the personal exemption phase-out.
- Other provisions: Other taxpayer-favorable provisions were
permanently extended, including those related to
- Children and child care (the $1,000 child tax credit, the adoption credit and exclusion from income for employer-provided adoption assistance, the employer-provided child care tax credit, and the dependent care tax credit);
- Marriage penalty relief (basic standard deduction, the size of the 15% bracket, and the earned income tax credit or "EITC"); and
- Various education incentives (the provisions relating to the NHSC Scholarship Program and the Armed Forces Scholarship Program, the section 127 exclusion from income and wages for employer-provided educational assistance, the student loan interest deduction, Coverdell education savings accounts, the expansion of the small government unit exception to arbitrage rebate, and the issuance of tax-exempt private activity bonds for public school facilities).
II. Permanent Extension of AMT Patch. The increase in the alternative minimum tax ("AMT") exemption amount, or "AMT patch," which expired at the end of 2011, was made permanent and indexed for inflation, along with AMT relief for nonrefundable credits.
III. Temporary Extension of American Recovery and Reinvestment Act Provisions. Five-year extensions were provided to the following provisions, which expired on December 31, 2012:
- American Opportunity Tax credit
- Refundable child credit floor amount
- Special earned income tax credit rules
IV. Tax Extenders. The Act includes the extensions (and expansions) in S. 3521 as approved by the Senate Finance Committee in August 2012, plus a one-year extension of 50% bonus depreciation.
Accordingly, the following provisions that expired at the end of 2011 are retroactively extended for 2 years so that they will now expire at the end of 2013:
- Research and experimentation tax credit (extension and modification)
- Provisions directed at individuals
- Deduction for certain expenses of elementary and secondary school teachers
- Parity for exclusion for employer-provided mass transit and parking benefits
- Deduction for mortgage insurance premiums
- Deduction for State and local general sales taxes
- Special rules for contributions of capital gain real property made for conservation purposes
- Above-the-line deduction for qualified tuition and related expenses
- Tax-free distributions from individual retirement plans for charitable purposes
- Energy-related provisions
- Credit for certain nonbusiness energy property
- Credit for electric motorcycles and three-wheeled vehicles
- Alternative fuel vehicle refueling property (non-hydrogen refueling property)
- Incentives for biodiesel and renewable diesel
- Credit for construction of new energy efficient homes
- Credit for energy efficient appliances
- Special rule for sales or dispositions to implement FERC or State electric restructuring policy
- Incentives for alternative fuel and alternative fuel mixtures (other than liquefied hydrogen)
- Provisions directed at businesses
- Indian employment tax credit
- New markets tax credit
- Credit for certain expenditures for maintaining railroad tracks
- Mine rescue team training credit
- Employer wage credit for activated military reservists
- Work opportunity tax credit
- Allocation of bond limitation on Qualified Zone Academy Bonds
- Treatment of military basic housing allowances under low-income housing credit
- 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements
- 7-year recovery period for motorsports entertainment complexes
- Accelerated depreciation for business property on an Indian reservation
- Enhanced charitable deduction for contributions of food inventory
- Increase in expensing to $500,000/$2,000,000 and expansion of definition of section 179 property
- Election to expense advanced mine safety equipment
- Special expensing rules for certain film and television productions
- Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico
- Modification of tax treatment of certain payments to controlling exempt organizations
- Treatment of certain dividends of regulated investment companies (RICs)
- RIC qualified investment entity treatment under FIRPTA
- Exceptions under subpart F for active financing income
- Look-through treatment of payments between controlled foreign corporations under the foreign personal holding company rules
- 100% exclusion of gain on sale of qualified small business stock
- Basis adjustment to stock of S corporations making charitable contributions of property
- Reduction in S corporation recognition period for built-in gains tax
- Empowerment zone tax incentives
- Economic development credit for American Samoa
- New York Liberty Zone tax-exempt bond financing
- Increase in limit on rum coverover
A few "extenders" which expired at the end of 2012 were extended through 2013, including
- 50% "bonus" depreciation
- Cellulosic biofuel producer credit (extension and expansion)
- Rules for determining the applicable percentage of low income housing tax credit
- Placed-in-service date for wind and certain other renewable resource facilities eligible to claim the electricity production credit and election to treat qualified facilities as energy property
- Credit for production of Indian coal
- Relief from discharge of indebtedness on principal residence
- Special depreciation allowance for cellulosic biofuel plant property
Only a couple of new "extenders" were made permanent: the provisions relating to favorable treatment of refunds in administration of certain federal programs and disclosure of prisoner tax return information.
V. Extension of Non-Tax Provisions
The Act extends, through 2013, certain expiring programs, including
- The temporary unemployment benefits program
- Temporary Medicare Payment Rates for Physicians (the "doc fix")
- A package of Medicare and other health care "extenders" and related provisions
- The 2008 Farm Bill (though September 30, 2013)
VI. Temporary Delay in Sequester and Additional Provisions
The Act delays, for two months, the across-the-board spending cuts ("sequester") mandated by the Budget Control Act and scheduled to begin in January 2013. To "pay" partially for this delay, the Act raises revenue by liberalizing the Roth conversion rules for retirement plans. The Act also eliminates the cost of living adjustment that would be available to the salaries of Members of Congress in the 2013 fiscal year.
VII. Not Included
- Temporary Payroll Tax Reduction. The 2% point reduction in the employee share of social security taxes expired on December 31, 2012. Accordingly, going forward, social security tax rates have returned to their full rate. Further, the new 0.9% additional Medicare tax on wages and self-employment income means that payroll taxes (at least for upper-income earners) will be higher than they were under pre-2010 law.
- 100% Bonus Depreciation. This incentive expired at the end of 2011. 50% bonus depreciation was extended for one year, however.
- Extenders that expired at the end of 2011 but which were not included in the package approved by the Senate Finance Committee in August. These include the so-called section 1603 program and certain other energy-related incentives.
- Relief from new tax provisions entering into effect in 2013. For example, the Act did not modify the revenue raisers that were adopted as part of health care reform and scheduled to take effect in 2013. These include the new Medicare tax on net investment income of upper-income individuals and the new taxes on medical device manufacturers.
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