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Perspective on Tax Planning

January 2013

The American Taxpayer Relief Act: Implications and Potential Opportunities for High-Income Taxpayers

On January 2, 2013, President Barack Obama signed into law the “American Taxpayer Relief Act of 2012.” Most of the tax law changes introduced in this legislation will affect high-income taxpayers, who face the first major tax increase in 20 years.

WHAT THIS NEW ACT MEANS TO HIGH-INCOME TAXPAYERS

While income tax rates remain unchanged for most Americans, high-income earners will likely see a significantly higher tax bill in 2013 and beyond, primarily due to raised income, estate and gift tax rates and the personal exemption phase-out as well as limitations on itemized deductions. These tax changes are highlighted below.

Many families will welcome a permanent extension of the lifetime estate and gift tax exemption which remains at $5 million, indexed for inflation. There is also favorable news if you are a taxpayer over age 70 ½ and are required to take annual required minimum distributions from your IRA: The Act restores for 2012 and 2013 a provision allowing tax-free distributions from IRAs, up to $100,000 per taxpayer, for charitable purposes. This provision expired in 2011. In addition, a special rule permits distributions made in December 2012 to be considered a tax-free transfer to charities, assuming the transfer is made to the charity before February 1, 2013. Another special rule permits taxpayers to deem distributions made in January 2013 as made in 2012.

BUT IMPORTANT DECISIONS HAVE NOT YET BEEN MADE

This Act focuses only on the tax aspects of our nation’s “fiscal cliff” — many issues related to federal spending and other revenue-raising remain unaddressed. There are several tax-related changes Congress could consider over the months to come — changes like mandating a minimum 10-year term for Grantor Retained Annuity Trusts (GRATs) or limiting the benefits of grantor trusts.  

Highlights of the American Taxpayer Relief Act of 2012

Higher Income Tax Rates
Individuals with taxable income over the new $400,000 threshold ($450,000 for married couples filing jointly)* will be taxed at higher rates:

  • The individual tax rate for income over this new threshold will rise from 35% in 2012 to 39.6% in 2013.
  • The long-term capital gains and qualified dividends tax rate for taxpayers whose income is over this new threshold will rise from 15% in 2012 to 20% in 2013 on the amounts over the thresholds. In reality, these taxpayers will pay 23.8% in taxes on these gains and dividends because of the new 3.8% Medicare tax on net investment income. The Medicare tax applies to individuals with a modified Adjusted Gross Income (AGI) of $200,000 or more ($250,000 for married couples filing jointly). It’s important to note that taxpayers whose ordinary income is below the 25% income tax rate will not pay any tax on their long-term capital gains or qualified dividends.

In addition, the Social Security Tax on payroll for all taxpayers will be reinstated to 6.2% in 2013, from 4.2% in 2012.

The Phase-Out of Personal Exemptions and the Itemized Deduction Limitation
Individuals with an AGI over the $250,000 threshold ($300,000 for married couples filing jointly)* will derive less benefit from the personal exemption and from itemized deductions, including the charitable deduction and mortgage interest deduction:

  • Personal exemptions will be reduced by 2% for each $2,500 of AGI that exceeds this threshold. For example, a married, childless couple that earned $400,000 in 2013 could have their personal exemption amount reduced by over $6,000.
  • Itemized deductions will be reduced by 3% of the amount of AGI exceeding this threshold. If, for example, the same married couple earned $400,000 and claimed $50,000 in itemized deductions, the value of those deductions could be reduced by $3,000 or 6% as a result of this limitation. There is, however, a ceiling on this limitation and taxpayers cannot lose more than 80% of their itemized deductions.

Permanent Alternative Minimum Tax (AMT) Relief
The Act permanently increases AMT exemptions retroactively to 2012 to $50,600 for single taxpayers ($78,750 for married couples filing jointly). Without the retroactive increase, the AMT exemption amount for 2012 would have been $33,750 for single taxpayers ($45,000 for married couples filing jointly). The AMT exemption amount will be indexed for inflation.

A Higher Maximum Estate and Gift Tax Rate and a Permanent Lifetime Exemption
The maximum estate, gift, and Generation-Skipping Transfer (GST) tax rate is now 40%, up from the 35% rate. The lifetime exemption, however, remains at $5 million, indexed for inflation. It’s also important to know that this legislation makes portability permanent, which means the surviving spouse may elect to use his or her deceased spouse’s unused gift and estate tax exemption, thereby maximizing both spouses’ lifetime exemptions. The Act did not affect the unlimited exclusion for educational and medical payments or the annual gift tax exclusion amount, which will increase, as scheduled, to $14,000 for 2013.

 

This communication is intended solely to provide general information. The information and opinions stated are as of January 4, 2013, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods. IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor. 

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