Highlights of the Fiscal Cliff Tax Provisions

Highlights of the Fiscal Cliff Tax Provisions The House of Representatives passed the Senate's Fiscal Cliff  bill, which President Obama has promised to sign. What follows is a summary of the tax provisions of the bill that are particularly relevant to business owners and high net worth individuals:

Increase in Tax Rates

  • The tax rate on ordinary income over $450,000 (joint returns), $425,000 (head of household) or $400,000 (single) has increased from 35% to 39.6%.
  • The tax rate on long-term capital gain and dividends increased from 15% to 20% for income in excess $450,000 (joint returns), $425,000 (head of household) or $400,000 (single).
  • Keep in mind that the "Obamacare" surtax of 3.8% applies to passive income, such as dividends and capital gain for taxpayers with "modified" adjusted gross income in excess of $250,000 (joint returns) or $200,000 (other taxpayers).

Limitation on Deductions and Personal Exemptions

For taxpayers with adjusted gross income (AGI) in excess of $300,000 (joint returns), $275,000 (head of household) or $250,000 (single), the law reenacts the prior rules:

  • Itemized deductions will be reduced by 3% of a taxpayer's AGI over the threshold amount, but not in excess of 80% of AGI.
  • Personal exemptions are reduced by 2 percentage points for each $2500 (or fraction thereof) by which the taxpayer's AGI exceeds the threshold amount.

Alternative Minimum Tax

  • The Alternative Minimum Tax increased the exclusion to $50,650 (single) and $78,750 (joint returns) for 2012.

Social Security (FICA) and Medicare Tax

  • In 2012, an employee's FICA tax was 4.2% of the first $110,100 of wages. This rate represented a temporary reduction of 2 percentage points from the prior 6.2% rate. The new law, by not extending the prior temporary reduction, reinstates the 6.2% rate and at the same time, the wage base on which the tax is paid increased to $113,700. If an employee receives at least $113,700 of wage and salary income in 2013, his or her FICA tax will increase by $2,400 as compared with 2012.
  • The Obamacare surtax will increase the Medicare tax on taxpayers with adjusted gross income in excess of $250,000 (joint returns) or $200,000 (other taxpayers) from 1.45% to 2.35% for wages and salary in excess of these amounts.
  • Partners and self-employed individuals will have similar tax increases. The overall FICA tax will increase from 10.4% to 12.4% of the first $113,700 of self-employment income. The Medicare tax will increase from 2.9% to 3.8% for income over the $200,000 or $250,000 threshold amounts.

Estate Tax

  • The estate, gift and generation skipping tax is raised from 35% to now 40% over $5 million (as indexed for inflation).
  • It appears that the 2013 exclusion will be approximately $5,250,000.
  • The rules allowing one spouse to transfer his or her unused credit to the other spouse remain in effect, allowing families to transfer more than $10 million tax free.

Depreciation

  • 50% Bonus Depreciation extended through 2013.
  • Qualified leasehold improvements for 2012 and 2013 are again eligible for 15-year depreciation.
  • IRS Code Section 179 allows taxpayers to deduct 100% of certain capital expenditures. The new law extends the increased limits ($500,000 of eligible capital expenditures, phasing out where taxpayers spend more than $2 million) to 2012 and 2013. Eligible items include qualified real property, including qualified leasehold expenditures.

S Corporations

  • The built-in gains "recognition period" is reduced from 10 years to 5 years for 2012 and 2013. This means that if a C Corporation converted to an S corporation more than five years ago, it may sell its assets without paying a corporate level tax on any appreciation that existed at the time of conversion.

Conservation Easements

  • Conservation easements contributed in 2012 and 2013 remain eligible for the 50% charitable deduction limitation and a 15-year carryover.

Charitable Contributions from IRAs

  • The ability to distribute up to $100,000 directly from an IRA to a qualified charity (without taking the contribution into income) was extended to 2012 and 2013.

Qualified Principal Residence Indebtedness

  • The law extends the relief to a taxpayer whose mortgage on his or her principal residence is forgiven or reduced through 2013. The taxpayer may reduce the tax basis of his or her home, instead of recognizing cancellation of indebtedness income.

Tax Credits/ Incentives

  • Low income housing and new markets credits and empowerment zone incentives were extended through 2013 (and longer in certain cases).

Energy Incentives

  • Tax credits related to green energy, including various residential tax credits, were extended through 2013 (and longer for certain credits).

Small Business Stock

  • The temporary exclusion of tax on gain recognized on the sale of eligible small business stock was extended through 2013.

Exempt Organizations

  • Certain payments, such as interest and rent, made by a taxable entity to a controlling exempt entity are treated as unrelated business taxable income. The bill extends, for 2012 and 2013, relief from the characterization of such payments as unrelated business taxable income if the payments would have qualified as reasonable under Section 482.
  • The new law also has a number of other tax provisions dealing with specific items, such as foreign tax rules and other depreciation matters.
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