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Tax basics of the “fiscal cliff” deal 

Tax basics of the “fiscal cliff” deal 

By Paul Bonner and Alistair M. Nevius 
January 03 2013

Pulling back from the “fiscal cliff” at the 13th hour, the US Congress on Tuesday preserved most of the George W. Bush-era tax cuts and extended many other lapsed tax provisions.
 
Shortly before 2am Tuesday, the Senate passed a bill that had been heralded and, in some quarters, groused about throughout the preceding day. By a vote of 89 to 8, the chamber approved the American Taxpayer Relief Act, H.R. 8, which embodied an agreement that had been hammered out on Sunday and Monday between Vice President Joe Biden, a Democrat, and Senate Minority Leader Mitch McConnell, a Republican. The House of Representatives approved the bill by a vote of 257–167 late on Tuesday evening, after plans to amend the bill to include spending cuts were abandoned. President Barack Obama signed the bill Wednesday.

“The uncertainty of the tax law has unnecessarily impeded the long-term tax and cash flow planning for businesses and prevented taxpayers from making informed decisions,” said Edward Karl, vice president–Tax for the American Institute of CPAs, adding that the Institute was pleased an agreement had been reached. “The agreement should also allow the (Internal Revenue Service) and commercial software vendors to revise or issue new tax forms and update software, and allow tax season to begin with minimal delay.”

With some modifications targeting the wealthiest Americans with higher taxes, the act permanently extends provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (EGTRRA), and Jobs and Growth Tax Relief Reconciliation Act of 2003, P.L. 108-27 (JGTRRA). It also permanently indexes for inflation the alternative minimum tax (AMT) exemption amounts for individuals. The AMT provisions were designed to prevent taxpayers with substantial economic income from avoiding tax liability by using certain exclusions, deductions and credits. Because the AMT exemption amounts for individuals were not automatically adjusted for inflation, the AMT annually threatened to ensnare a large number of middle-income individual taxpayers.

The act also temporarily extends many other tax provisions that had lapsed at midnight on December 31st and others that had expired a year earlier.

In addition, the act delays until March a broad range of automatic federal spending cuts known as sequestration that otherwise would have begun this month.

Among the tax items not addressed by the act was the temporary lower 4.2% rate for employees’ portion of the Social Security payroll tax, which was not extended and has reverted to 6.2%.

Here are the act’s main tax features:

Business tax extenders

The act extended many business tax credits and other provisions. Notably, it extended through 2013 and modified the Sec. 41 credit for increasing research and development activities, which expired at the end of 2011. The credit is modified to allow partial inclusion in qualified research expenses and gross receipts those of an acquired trade or business or major portion of one. The increased expensing amounts under Sec. 179 are extended through 2013. The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) was also extended for one year by the act. It now generally applies to property placed in service before January 1st 2014 (January 1st 2015 for certain property with longer production periods).

Other business provisions extended through 2013, and in some cases modified, are:

  • Temporary minimum low-income tax credit rate for non-federally subsidised new buildings (Sec. 42);
  • Housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds (Section 3005 of the Housing Assistance Tax Act of 2008);
  • Indian employment tax credit (Sec. 45A);
  • New markets tax credit (Sec. 45D);
  • Railroad track maintenance credit (Sec. 45G);
  • Mine rescue team training credit (Sec. 45N);
  • Employer wage credit for employees who are active duty members of the uniformed services (Sec. 45P);
  • Work opportunity tax credit (Sec. 51);
  • Qualified zone academy bonds (Sec. 54E);
  • Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e));
  • Accelerated depreciation for business property on an Indian reservation (Sec. 168(j));
  • Enhanced charitable deduction for contributions of food inventory (Sec. 170(e));
  • Election to expense mine safety equipment (Sec. 179E);
  • Special expensing rules for certain film and television productions (Sec. 181);
  • Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (Sec. 199(d));
  • Modification of tax treatment of certain payments to controlling exempt organisations (Sec. 512(b));
  • Treatment of certain dividends of regulated investment companies (Sec. 871(k));
  • Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Tax Act (Sec. 897(h));
  • Extension of subpart F exception for active financing income (Sec. 953(e));
  • Lookthrough treatment of payments between related controlled foreign corporations under foreign personal holding company rules (Sec. 954);
  • Temporary exclusion of 100% of gain on certain small business stock (Sec. 1202);
  • Basis adjustment to stock of S corporations making charitable contributions of property (Sec. 1367);
  • Reduction in S corporation recognition period for built-in gains tax (Sec. 1374(d));
  • Empowerment zone tax incentives (Sec. 1391);
  • Tax-exempt financing for New York Liberty Zone (Sec. 1400L);
  • Temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands (Sec. 7652(f)); and
  • American Samoa economic development credit (Section 119 of the Tax Relief and Health Care Act of 2006, P.L. 109-432, as modified).

Individual tax rates

All the individual marginal tax rates under EGTRRA and JGTRRA are retained (10%, 15%, 25%, 28%, 33%, and 35%). A new top rate of 39.6% is imposed on taxable income over $400,000 for single filers, $425,000 for head-of-household filers, and $450,000 for married taxpayers filing jointly ($225,000 for each married spouse filing separately).

Phase-out of itemised deductions and personal exemptions

The personal exemptions and itemised deductions phase-out is reinstated at a higher threshold of $250,000 for single taxpayers; $275,000 for heads of household; and $300,000 for married taxpayers filing jointly.
 
Capital gains and dividends

A 20% rate applies to capital gains and dividends for individuals above the top income tax bracket threshold; the 15% rate is retained for taxpayers in the middle brackets. The zero rate is retained for taxpayers in the 10% and 15% brackets.

Alternative minimum tax

The exemption amount for the AMT on individuals is permanently indexed for inflation. For 2012, the exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers.
 
Estate and gift tax

The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012), but the top tax rate increases from 35% to 40% effective January 1st 2013. The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act.
 
Permanent extensions

Various temporary tax provisions enacted as part of EGTRRA were made permanent. These include:

  • Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2));
  • The liberalised child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
  • Expanded adoption credit (Sec. 23) and adoption-assistance programme (Sec. 137) amounts;
  • The exclusion for National Health Service Corps and Armed Forces Health Professions scholarships (Sec. 117(c)(2));
  • The exclusion for employer-provided educational assistance (Sec. 127);
  • The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221);
  • The higher contribution amount and other EGTRRA changes to Coverdell education savings accounts (Sec. 530);
  • The employer-provided child care credit (Sec. 45F);
  • Special treatment of tax-exempt bonds for education facilities (Sec 142(a)(13));
  • Repeal of the collapsible corporation rules (Sec. 341);
  • Special rates for accumulated earnings tax and personal holding company tax (Secs. 531 and 541); and
  • Modified tax treatment for electing Alaska Native Settlement Trusts (Sec. 646).

Individual credits expired at the end of 2012

The American opportunity tax credit for qualified tuition and other expenses of higher education was extended through 2017. Other credits and items from the American Recovery and Reinvestment Act of 2009, P.L. 111-5, that were extended for the same five-year period include enhanced provisions of the child tax credit under Sec. 24(d) and the earned income tax credit under Sec. 32(b). In addition, the bill permanently extends a rule excluding from taxable income refunds from certain federal and federally assisted programmes (Sec. 6409).

Individual provisions expired at the end of 2011

The act also extended through 2013 a number of temporary individual tax provisions, most of which expired at the end of 2011:

  • Deduction for certain expenses of elementary and secondary school teachers (Sec. 62);
  • Exclusion from gross income of discharge of qualified principal residence indebtedness (Sec. 108);
  • Parity for exclusion from income for employer-provided mass transit and parking benefits (Sec. 132(f));
  • Mortgage insurance premiums treated as qualified residence interest (Sec. 163(h));
  • Deduction of state and local general sales taxes (Sec. 164(b));
  • Special rule for contributions of capital gain real property made for conservation purposes (Sec. 170(b));
  • Above-the-line deduction for qualified tuition and related expenses (Sec. 222); and
  • Tax-free distributions from individual retirement plans for charitable purposes (Sec. 408(d)).

Energy tax extenders

The act also extends through 2013, and in some cases modifies, a number of energy credits and provisions that expired at the end of 2011:

  • Credit for energy-efficient existing homes (Sec. 25C);
  • Credit for alternative fuel vehicle refuelling property (Sec. 30C);
  • Credit for two- or three-wheeled plug-in electric vehicles (Sec. 30D);
  • Cellulosic biofuel producer credit (Sec. 40(b), as modified);
  • Incentives for biodiesel and renewable diesel (Sec. 40A);
  • Production credit for Indian coal facilities placed in service before 2009 (Sec. 45(e)) (extended to an eight-year period);
  • Credits with respect to facilities producing energy from certain renewable resources (Sec. 45(d), as modified);
  • Credit for energy-efficient new homes (Sec. 45L);
  • Credit for energy-efficient appliances (Sec. 45M);
  • Special allowance for cellulosic biofuel plant property (Sec. 168(l), as modified);
  • Special rule for sales or dispositions to implement Federal Energy Regulatory Commission or state electric restructuring policy for qualified electric utilities (Sec. 451); and
  • Alternative fuels excise tax credits (Sec. 6426).

Foreign provisions

The Internal Revenue Service’s authority under Sec. 1445(e)(1) to apply a withholding tax to gains on the disposition of US real property interests by partnerships, trusts or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent, and the amount is increased to 20%.

New taxes

In addition to the various provisions discussed above, some new taxes also took effect January 1st as a result of 2010’s health care reform legislation.

Additional hospital insurance tax on high-income taxpayers. The employee portion of the hospital insurance tax part of payroll taxes, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse; $125,000 in the case of a married individual filing a separate return; and $200,000 in any other case.

For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of Self-Employment Contributions Act tax on self-employment income in excess of the threshold amount.

Medicare tax on investment income. Starting January 1st, Sec. 1411 imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (AGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins.
 
For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is $125,000; and, for other individuals, it is $200,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.

Medical care itemised deduction threshold. The threshold for the itemised deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.

Health flexible spending arrangement. Effective for plan years beginning after December 31st 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a health flexible spending arrangement for any plan year is $2,500.

Paul Bonner (pbonner@aicpa.org) is a CGMA Magazine senior editor and Alistair M. Nevius (anevius@aicpa.org) is the CGMA Magazine’s editor-in-chief, tax.

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5 Comments


Comments
Greville Liburd

We see in America today as well as on the world economic stage, the negative effects of those enormous, mind-boggling profits that were taken during better times, such as in the 1940s through the 1970s, and stored up and barricaded behind legal fences of private ownership rights. Although private ownership rights are very important and quite necessary in a free enterprise democracy, the practice of hoarding and cordoning off excessive private wealth has corrupted the system: Such practices  always tend to create a tug-of-war effect between private profit hoarding and government tax-grabbing.

It is clear from all economic indicators, that both the American and world economies are fast entering a black hole as was forecast by the world-renowned Harvard economist Dr. Lester Thurow in the late 1980s. Many factors account for this bewildering situation, but a more simple explanation could come from the analogy with a business such as Enron, where managers become too narrow-minded in thier focus for promoting excessive growth at the expense of sustainable liquidity, just to satisfy the enrichment of a special sector or few. The inevitable results are that the organization becomes bloated with devalued assets, and is financially weak and sick, and may eventually die. We cannot allow the economy of the United States of America, nor that of the world to die. It is the President?s job, with the full support of the Congress, to see that this does not happen.

The United States possesses more than enough wealth to pay its bills in full, and to take care of all of its citizens quite well. Simply put, the government is presently over-committed, and under-funded. It is over-committed because of the generally accepted but false notion that the government can be overcharged for everything, and will be able to overcome every economic setback eventually, and should be made responsible for helping the rich while it rations the poor. It is under-funded because of the very effective work that the business lobbyists do who are able to establish extremely advantageous relationships with U.S. legislators at federal, state and municipal levels. A fair and honest examination of this system can provide a solid basis to fix it.

Jan 6, 2013 6:17 PM
Comments
Charles Hallett

Whereas, I appreciate your observations, please understand there are basics that work for everyone, every business and every governmental agency.  These all related to revenues, spending and debt.

1  Revenues must exceed spending,

2  Spending can not exceed what can be reasonably paid for, and,

3  Do not incur debt you cannot pay for.

You do not need to be Einstein to understand this.  There is no exclusion for government.  There is no "gray area" becasue of what happens to GDP, unemployment or uncomfortable clothing.

Frankly, our government must solve this crisis.  While in practice, I counseled my clients that there are three types of people:  Some people make things happen, some people watch things happen, and some people wonder "what happened.  Which one are you".  I went on to further say, if you did not understand what I just said, you are in the last category.  Revenues, spending and debt must be fixed.

Jan 5, 2013 12:43 AM
Comments
Greville Liburd

The problems we wrestle with daily in our society are the inevitable results of the interaction between three pivotal forces that we have chosen largely to neglect or ignore out of convenience: Debt, taxes, and the tyranny of capitalism have insidiously corrupted our social conscience and stole our self-control. We argue among ourselves mainly to justify our moral self-delusions about these three culprits as we rationalize for our unfair claims to distorted chunks of  society?s resources.

The PEW Charitable Trusts suggested in a September 2010 report entitled  ?No silver bullet: Paths for reducing the Federal Debt,? that government should use a combined approach that would simultaneously increase revenues and decrease both discretionary and non-discretionary expenses. It also laid out three mutually exclusive scenarios, where the remedy is focused on fixing just one element such as revenues, or expenditures, to give the overall desired effect of balancing the budget. By this it showed that by just focusing on one problem element such as excessive expenditures, without making any adjustments to revenues or the capacity for growth, that this approach would create disproportionate risks and distortions in other major items in the budget.

A brief study of the government figures reported by the U.S Office of Management and Budget (OMB) for the years 1960-2010 reveals that  for the period 1998-2001, federal government receipts averaged approximately 20 percent of GDP compared with approximately 18 percent of GDP for outlays. When this performance is compared with the period 2002-2010, it shows an average ratio of approximately 16 percent for receipts, corresponding to an approximate average ratio for outlays of 21 percent. These figures clearly indicate that if it were possible for the government to hold both revenues and expenditures at about 20 percent of GDP instead - the rate of revenue intake for the previous four years ? there would likely have been no deficit spending, and that this move would have resulted instead, in an accumulated surplus that could be made available for reducing the current level of national debt.

Jan 4, 2013 1:04 PM
Comments
Charles Hallett

I am disappointed with this new law.  The income tax increases are simply a "blip" in what was needed.  There is a 3-fold problem that our elected officials must help solve.  That is:  Revenues, Spending and Debt.  This law "kicks the can down the road".  In other words, in my opinion, it does nothing but implies to the American people that progress was made.  Disappointing.

Jan 4, 2013 11:03 AM
Comments
Charles Hallett

I am disappointed with this new law.  The income tax increases are simply a "blip" in what was needed.  There is a 3-fold problem that our elected officials must help solve.  That is:  Revenues, Spending and Debt.  This law "kicks the can down the road".  In other words, in my opinion, it does nothing but implies to the American people that progress was made.  Disappointing.

Jan 4, 2013 11:03 AM
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