Without action by Congress and the President, there are several tax provisions scheduled to expire at the end of this year. Without proper tax planning, you could be unpleasantly surprised with a big tax bill this April because of the AMT (Alternative Minimum Tax) or a significant increase in your withholding taxes come January 1st, 2013.
Below is a detailed description of specific expiring tax provisions provided by Baker Tilly. If you want to know how any of these changes might impact you, please contact me to schedule an appointment. (734) 377-3641 or by e-mail email@example.com.
Expiration of Bush tax cuts and other provisions
Effective Jan. 1, 2013 (barring any legislative action during the remainder of 2012), the “Bush tax cuts,” among other tax provisions, are set to expire. What does this mean to you?
- The highest income tax bracket for filers whose status is married filing jointly, will increase to 39.6 percent from the current 35 percent for taxable income in excess $379,650.
- The tax on long-term capital gains will increase to 20 percent from 15 percent.
- The tax on qualified dividends will increase to ordinary income rates (top rate of 39.6 percent) from 15 percent.
- The two marriage penalty patches will expire. The standard deduction for married couples will revert to 167 percent of the standard deduction for single filers. Also, the upper limit of the 15 percent bracket for married couples will revert to 167 percent of the upper limit for single filers.
- The child tax credit will decrease to $500 from $1,000; phasing out when incomes exceed $110,000 (married, filing joint returns).
- The child and dependent care credit decreases to $2,400 per dependent (maximum $4,800) from $3,000 (maximum $6,000) per dependent.
- The personal exemption phase-out (PEP) and Pease (limitation on itemized deductions) provisions will be reinstated to their original levels, projected to be $174,750 for single taxpayers and $261,650 for married filing joint taxpayers. This means for taxpayers with AGI in excess of these amounts, they lose the benefit of their personal exemptions and their itemized deductions will once again be limited.
- The current Internal Revenue Code (IRC) section 179 deduction of $500,000 will revert back to $25,000, with a cap on qualified expenses of $200,000.
- Bonus depreciation will be eliminated.
- Accumulated earnings tax imposed on certain corporations increases to 39.6 percent from 15 percent.
- The 2 percent payroll tax cut will expire (reducing take-home pay for employees and increasing self-employment tax for qualifying individuals).
- The Medicare rate for individuals with gross wages (or self-employment income) in excess of $200,000 will increase to 2.35 percent from 1.45 percent.
- The small employer health care credit will disappear.
- The estate tax rate will revert to 55 percent and the exemption amount will decrease to $1 million (from $5 million).
These changes will have a significant impact on taxpayers in 2013. For example, a taxpayer with taxable income of $1 million, 50 percent of which is qualified dividends, will see their tax liability increase to $415,000 from $250,000.
Suggestions to mitigate the impact of these tax increases include:
- If planning to sell your business, try to close the sale in 2012 (e.g., if the sale created a gain of $10 million, waiting until 2013 may cost an additional $500,000 in capital gains tax).
- Remember gain from installment sale payments is taxed in the year received; payments received in 2013 on a 2012 sale would be subject to the higher capital gains rates.
- Plan to make capital improvements in 2012 to take advantage of 50 percent bonus depreciation and $125,000 IRC section 179 deductions.
- Distribute bonus payouts in 2012 to mitigate the employee payroll tax increase.
- With respect to estate and gift planning, consider exhausting the $5 million exclusion by making gifts in 2012.
- Consider accelerating income to 2012 to take advantage of the lower rates in 2012. Likewise you may want to defer deductions until 2013 to take advantage of the higher rates in that year.
- Qualified corporations should consider accelerating dividend payments to 2012 to take advantage of the last year for the lower tax rate.
- Contemplate adjusting your income tax withholding and/or estimated tax payments in early 2013 to account for any loss of itemized deductions, child and child care credits, and personal exemptions.
- Consider converting an IRA to a Roth IRA before income tax rates increase
Expiration of certain tax provisions as of Dec. 31, 2011
While the employee payroll tax cut was extended, 60 other provisions were allowed to expire as of Dec. 31, 2011 (with another 41 set to expire at the end of 2012). It is unclear, given the current political climate and election-year campaigning, whether any of these will be retroactively reinstated back to Jan. 1, 2012, in future tax legislation.
Some of the notable provisions that have already expired include:
- Deduction for state and local general sales taxes
- Research credit
- 15-year straight-line cost recovery for qualified leasehold improvements, restaurant buildings and improvements, and retail improvements
- Reduction in S corporation recognition period for built-in gains tax
- Energy-efficient appliance credit
- New Markets Tax Credit
- Work Opportunity Tax Credit
- Employer wage credit for military reservists
- Several empowerment zone incentives
- Sales tax deduction instead of state income tax deduction
Alternative minimum tax
The AMT was originally enacted in 1969 to ensure higher income taxpayers pay a minimum amount of income tax. Taxpayers are required to calculate their tax liability using regular tax rates and again using the AMT rules, which require certain preference items be added back to taxable income to compute their AMT tax base. The basic exemption is then subtracted from the tax base and the AMT tax rate of 26 or 28 percent is applied. Taxpayers pay the greater of regular tax or AMT. The basic exemption is not indexed for inflation, but generally every year Congress increases the amount of the basic exemption (the AMT patch).
For 2012, the AMT basic exemption is $45,000 for married filing joint and $33,750 for single filers. Without congressional action, an estimated 30 million taxpayers will be subject to AMT in 2012. In the current political and legislative environment, the chance of another AMT patch being enacted before the November elections is questionable. In addition, prior to 2012, all nonrefundable personal tax credits were allowable against AMT liability. Beginning Jan. 1, 2012, only certain nonrefundable credits are allowed against the AMT liability.