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American Taxpayer Relief Act (ATRA) of 2012

In the waning hours of January 1, Congress passed the American Taxpayer Relief Act (ATRA) of 2012 as part of an effort to resolve the fiscal cliff dilemma. President Obama signed the Act into law on January 2. An important provision in the new law is the permanent extension of lower tax rates for low, middle, and upper-middle income taxpayers for 2013 and later years. The 10 percent (i.e., lowest) individual income tax bracket that was scheduled to expire at the end of 2012, has been permanently extended. The 25, 28, 33, and 35 percent individual income tax brackets that were also scheduled to expire at the end of 2012 have been permanently extended. While the new law reduces taxes on many low, middle, and upper-middle income taxpayers, it is not so favorable for high-income taxpayers. Under ATRA, higher tax rates apply to taxpayers with adjusted gross income above certain thresholds (i.e., $400,000 for individual filers, $425,000 for heads of households, $450,000 for married taxpayers filing jointly, and $225,000 for married filing separately status). The top tax rate is 39.6 percent.

Additionally, while the lower capital gain rates of zero and 15 percent were extended for taxpayers in the 25 percent and lower tax brackets, the capital gain rate for taxpayers in higher tax brackets is increased to 20 percent. As under prior law, higher rates apply to gain or loss from the sale of collectibles and the eligible gain from the sale of qualified small business stock, as well as unrecaptured Section 1250 gain, regardless of the taxpayer's tax bracket.

Permanent Repeal of Personal Exemption Phase-out

Under the personal exemption phase-out (PEP), personal exemptions are phased out for taxpayers with adjusted gross income (AGI) above a certain level. Previous legislation temporarily repealed the PEP through 2012. ATRA permanently extends the repeal of the PEP on incomes at or below $250,000 (individual filers), $275,000 (heads of households) and $300,000 (married filing jointly), and $150,000 (married filing separately) for tax years beginning after December 31, 2012.

Permanent Repeal of Deductions Limitation

Generally, taxpayers itemize deductions if their total deductions are more than the standard deduction amount. Under prior law, the amount of itemized deductions a taxpayer could claim was reduced to the extent the taxpayer's AGI was above a certain amount. This rule was temporarily repealed for itemized deductions through 2012. ATRA permanently extends the repeal of the deduction limitation on incomes at or below $250,000 (individual filers), $275,000 (heads of households), $300,000 (married filing jointly), and $150,000 (married filing separately) for tax years beginning after December 31, 2012.

Modifications to Estate Tax; Portability Made Permanent

Legislation enacted in 2001 phased out the estate and generation-skipping transfer taxes so that they were fully repealed in 2010, and lowered the gift tax rate to 35 percent and increased the gift tax exemption to $1 million for 2010. Legislation enacted in 2010 set the exemption at $5 million per person with a top tax rate of 35 percent for the estate, gift, and generation skipping transfer taxes for two years, through 2012. The exemption amount was indexed beginning in 2012. ATRA makes permanent the indexed exclusion amount and indexes that amount for inflation going forward, but sets the top tax rate at 40 percent for estates of decedents dying after December 31, 2012. The exclusion is $5,120,000 and $5,250,000 for 2012 and 2013, respectively.

ATRA also permanently extends unification of the estate and gift taxes and makes permanent the provision that allowed the executor of a deceased spouse's estate to transfer any unused exemption amount to the surviving spouse.

Permanent Alternative Minimum Tax Relief

ATRA increases the alternative minimum tax (AMT) exemption amounts for 2012 to $50,600 (individuals), $78,750 (married filing jointly), and $39,375 (married filing separately). These amounts are substantially higher than the exemption amounts that were scheduled to be in effect for 2012. Thus, many individuals that might have been subject to the AMT for 2012 will escape the additional tax imposed by the AMT. While ATRA increased the Alternative Minimum Tax (AMT) exemptions for 2012, those exemptions phase out for income over certain amounts. The exemption amounts for 2012 are $78,750 (joint return), $50,600 (single and head of household), $39,375 (married filing separately) and are reduced (but not below zero) by an amount equal to 25 percent of the amount by which the alternative minimum taxable income of the taxpayer exceeds (1) $150,000 in the case of a joint return or a surviving spouse; (2) $112,500 in the case of an individual who is unmarried and not a surviving spouse; and (3) $75,000 in the case of a married individual filing a separate return. ATRA indexes the exemption and phase-out amounts for years after 2012 and allows nonrefundable personal credits to reduce AMT.

The new law extended several favorable provisions from the Bush era tax cuts. The following are some ATRA extensions that may help reduce your taxes this year.

Extension of Deduction for Expenses of Elementary and Secondary School Teachers

The rule that allowed elementary and secondary school teachers to deduct from gross income up to $250 of qualified expenses they paid during the year ($500 on a joint return if both spouses were eligible educators) expired for tax years beginning after 2011. ATRA extends the deduction through tax years beginning before 2014.

Extension of Exclusion of Income from Discharge of Qualified Principal Residence Indebtedness

For certain tax years before 2013, taxpayers could exclude from income the discharge of qualified principal residence debt. This provision was scheduled to expire for debt discharged after December 31, 2012. ATRA extends the exclusion to debt that is discharged before January 1, 2014.

Extension of Tax-Free Distributions from IRAs for Charitable Purposes

A qualified charitable distribution (QCD) from an IRA is excluded from gross income. This exclusion expired for distributions made in tax years after December 31, 2011. ATRA extends the availability of the exclusion to distributions made in tax years beginning after December 31, 2011, and before January 1, 2014.

If a taxpayer makes a QCD during January 2013, he or she can elect to have the QCD treated as if it were made in 2012. Also, the taxpayer may treat any portion of a distribution from an IRA during December 2012 as a QCD to the extent (1) that portion is transferred in cash after the distribution to an eligible charitable organization before February 1, 2013, and (2) that portion is part of a distribution that would meet the requirements of QCD but for the fact that the distribution was not transferred directly to the organization.

Extension of Special Rule for Contributions of Capital Gain Real Property Made for Conservation Purposes

The deduction for qualified conservation contributions is generally limited to 50 percent of adjusted gross income (100 percent, in the case of certain qualified farmers and ranchers), minus the deduction for all other charitable contributions. In other words, the 30-percent limitation on contributions of capital gain property by individuals does not apply to qualified conservation contributions. The special percentage limitations expired for contributions made after December 31, 2011. ATRA extends the availability of the special percentage limitations to contributions made in tax years beginning before January 1, 2014.

Extension of State and Local General Sales Taxes Deduction

The election to deduct state and local general sales taxes (instead of state and local income taxes) as an itemized deduction was to expired for tax years after December 31, 2011. ATRA extends the availability of that election to tax years beginning before January 1, 2014.

Extension of Temporary Exclusion of 100 Percent of Gain on Certain Small Business Stock

A noncorporate taxpayer can exclude 50 percent (60 percent for certain empowerment zone businesses) of gain from the sale of certain small business stock acquired at original issue and held for at least five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, the exclusion was increased to 75 percent. For stock acquired after September 27, 2010 and before January 1, 2012, the exclusion was 100 percent and the AMT preference item attributable for the sale is eliminated. Qualifying small business stock is from a C corporation whose gross assets do not exceed $50 million (including the proceeds received from the issuance of the stock) and who meets a specific active business requirement. The amount of gain eligible for the exclusion is limited to the greater of ten times the taxpayer's basis in the stock or $10 million of gain from stock in that corporation.

ATRA extends the 100-percent exclusion and the exception from minimum tax preference treatment for two years (i.e., for stock acquired before January 1, 2014). In the case of any stock acquired after February 17, 2009, and before January 1, 2014, the date of acquisition for purposes of determining the percentage exclusion is the date the holding period for the stock begins.

Extension of Credit for Energy-Efficient Existing Homes

A taxpayer is allowed a 10-percent nonbusiness energy property credit for the purchase of qualified energy efficiency improvements to existing homes. Additionally, a taxpayer can claim specified credits for the purchase of specific energy efficient property originally placed in service by the taxpayer during the tax year. There is a lifetime limitation of $500 on the total amount of nonbusiness energy property credit that may be claimed. There are also dollar limitations on the amount of the credit that may be claimed for specific types of qualified energy efficiency improvements and residential energy property. This credit was to expire for any property placed in service after December 31, 2011. ATRA extends the availability of the credit to property placed in service before January 1, 2014.

Extension of Mortgage Insurance Premiums Treated as Qualified Residence Interest

A taxpayers' ability to treat qualified mortgage insurance as qualified residence interest expired for amounts paid or accrued after December 31, 2011, or for amounts properly allocable to any period after that date. ATRA extends this treatment to amounts paid or accrued before January 1, 2014 (and not properly allocable to any period after 2013).

Extension of Above-the-Line Deduction for Qualified Tuition and Related Expenses

For years before 2012, taxpayers with modified adjusted gross income below certain thresholds could deduct up to $4,000 of qualified education expenses paid during the year for themselves, their spouses, or their dependents. The maximum deduction was $4,000 for an individual whose adjusted gross income for the tax year did not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose adjusted gross income did not exceed $80,000 ($160,000 in the case of a joint return). ATRA extends the availability of the deduction to tax years beginning before January 1, 2014.

Extension of Student Loan Interest Deduction

Taxpayers with modified adjusted gross income below certain thresholds may deduct up to $2,500 of interest paid on a qualified student loan in computing adjusted gross income. This provision was scheduled to be repealed and replaced with a less generous provision for tax years beginning after 2012. However, ATRA extends permanently the up-to-$2,500 deduction rule.

Extension of Credit for Two- or Three-Wheeled Plug-in Electric Vehicles

ATRA reforms and extends for two years, 2012 and 2013, the individual income tax credit for highway-capable plug-in motorcycles and three-wheeled vehicles.

Extension of American Opportunity Tax Credit

ATRA also extended the American Opportunity tax credit for five years through 2018. A taxpayer who pays qualified education expenses may elect to claim an American opportunity tax credit of up to $2,500 per year for each eligible student. The amount of the credit for each student is computed as 100 percent of the first $2,000 of qualified education expenses paid for the student and 25 percent of the next $2,000 of such expenses paid.

Child Tax Credit

The child tax credit was scheduled to be reduced from $1,000 to $500 in 2013. ATRA makes the $1,000 child tax credit permanent and extends for five years certain modifications relating to the additional child tax credit that will enable more individuals to claim the credit.

Earned Income Tax Credit

Working families with two or more children currently qualify for an earned income tax credit equal to 40 percent of the family's first $12,570 of earned income. Prior law increased that percentage to 45 percent for families with three or more children for tax years through 2012. ARTA extends the 45 percent rate for such families through 2017. ARTA also increases the beginning point of the phase-out range for all married couples filing a joint return (regardless of the number of children) to lessen the marriage penalty.

Marriage Tax Penalty Relief

ATRA permanently extends marriage tax penalty relief for the standard deduction, the 15 percent bracket, and the earned income tax credit for tax years beginning after December 31, 2012.

OTHER ITEMS OF INTEREST

Roth IRA Conversions

Effective for 2010 and beyond, taxpayer-friendly rules for Roth IRA conversions apply. Individuals may convert funds from a traditional IRA, 401(k) plan or certain other qualified plans to Roth IRAs, regardless of income. The traditional IRA or plan can make the distribution directly to a new or existing Roth IRA (a trustee-to-trustee transfer) or to the taxpayer to deposit into a Roth IRA within 60 days.

Taxes paid from conversion should come from non-retirement assets. If a taxpayer intends on using funds from the amount rolled over, the withdrawal is subject to a 10-percent penalty, in addition to the tax, if the taxpayer is under age 59 1/2 and not disabled.

Taxpayers with 2010 conversions to a Roth IRA have a choice either to recognize the income on the conversion in 2010 or, under a default provision, allow it to be recognized evenly over 2011 and 2012.

Social Security wage base

The maximum amount of earnings subject to the Social Security tax (taxable maximum) for 2013 is $113,700.

Business mileage rate

The business standard mileage reimbursement rate for 2013 will be 56.5 cents-per-mile, a one cent increase from 55.5 cents-per-mile for 2012.

Beginning on January 1, 2013, the mileage rate for medical or moving purposes will be 24 cents-per-mile and the rate for miles driven in service of charitable organizations will be 14 cents-per-mile.

Age for kiddie tax applicability

The kiddie tax was expanded beginning in 2008 by the Small Business and Work Opportunity Tax Act of 2007 to apply to any child that is 18 years old at the end of the tax year or who is a full-time student over the age of 18, but under 24 at the end of the year. If a child is over the age of 17, the kiddie tax will not apply if the child provides more than half of his or her own support through earned income.

Thus the net investment income of a child is now subject to the kiddie tax under the following circumstances, respectively, assuming that he or she has a living parent and does not file a joint return:

(A) 17-year-old or younger —will continue to be subject to the kiddie tax regardless of the amount of his or her own support provided with earned income;

(B) 18-year-old —subject to the kiddie tax unless the child provides more than half of his or her own support with earned income;

(C) 19- to 23-year-old student —subject to kiddie tax unless the child provides more than half of his or her own support with earned income.

Under the rule, college age students with investment income, whether from savings accounts or appreciated investment sales, will be required to use the parents' tax rate in calculating their personal income tax liabilities if their investment income exceeds certain limits and they do not provide more than half of their own support with earned income.

Gift Tax Annual Exclusion beginning 2013

The amount of annual gifts that can be given to any one individual in 2013 is $14,000.00. The exclusion amount is indexed for inflation in $1,000.00 increments and did not changed from the limit of $13,000.00 since 2009.

Check 21 -- Proving Tax Deductions Without Canceled Checks

The Check Clearing for the 21st Century Act (Check 21) became effective on October 28, 2004. Most consumers no longer see any of their checks after sent off as payment with a bill or other statement. Instead, Check 21 allows your bank to truncate each of your checks and create a new electronic negotiable instrument called a substitute check. After doing this, your bank destroys your original check.

How does Check 21 change the way you can prove an expense to the IRS in order to be entitled to a tax deduction or credit?

The short answer is that, for most taxpayers, Check 21 means you will need to keep your past bank statements in good order. The IRS says that it will accept bank statements that contain images of canceled checks and/or substitute checks. To be used as proof, an account statement must show check number, amount, payee's name, and the date the check was posted.

In order to keep track of your payments more easily for tax purposes, you should also maintain a careful check register. That way, you will know on which bank statement to look if you are ever audited.

Form 1099 Filing Requirements

Form 1099 is required to be filed for each person you pay $600 or more during the year for services in a trade or business. "Trade or business" in this context includes any business and some rental activities. Therefore, if you pay $600 or more for services to an individual or an unincorporated business for your business or rentals, you are required to file Form 1099 for that individual or entity. Form 1099 is filed with the related Form 1096, which summarizes the total amounts reported on the Forms 1099.

Forms 1096 and 1099 must be mailed to the IRS by February 28. The recipient copies of Forms 1099 are due to the payees by January 31. Failure to report independent contractor payments could result in substantial penalties for non-filing.

The State of California imposes even more filing requirements for payments to independent contractors. Form DE 542 must be filed with the State of California within 20 days of either making payments totaling $600 or more, or entering a contract for $600 in any calendar year, whichever is earlier. California can disallow the deduction of payments made to independent contractors if Form DE 542 is not filed.

Please contact us if you need our help in complying with the independent contractor rules.

Business use of automobiles

Many people use their automobiles for business and deduct the business portion of the automobiles on their income tax returns. One of the requirements allowing the deduction of these expenses is a contemporaneous mileage record. A recent Tax Court case has substantially narrowed the definition of "contemporaneous" business usage. In this case, the taxpayer upon audit reconstructed his mileage log using fixed distances to business appointments based upon a computer atlas database. The business appointments had been noted in his calendar as they occurred.

The Tax Court adhered to a strict reading of the law and disallowed the taxpayer's mileage amounts. The Court held that the taxpayer must indicate on his mileage log the actual odometer readings as the travel occurs in order to properly calculate the taxpayer's actual mileage for the year. Failure to keep track of mileage with odometer readings results a low degree of credibility in the Tax Court's opinion.

This ruling mandates a requirement to maintain odometer readings as the travel occurs. The failure to maintain odometer readings will result in a disallowance of your business automobile deductions. The disallowance will occur whether you claim actual deductions for the automobile usage or merely a "cents per mile" deduction. Please contact us if you need guidance regarding this ruling.

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