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The Tax Practice of IIT Chicago-Kent College of Law
The Tax Practice of IIT Chicago-Kent College of Law


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Crisis Averted? Congress Passes the American Taxpayer Relief Act

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Even the most cynical amongst us knew this was going to happen. As the new year turned, Congress finally got its act together and passed an omnibus bill to prevent the country from going over the fiscal cliff. Confirming most of what both astute and mediocre tax professionals were advising their clients before year’s end ("well, it’s a pretty safe bet that taxes won’t go down"), most all significant tax breaks were extended, social security taxes increased, and the wealthiest Americans will indeed be subjected to a higher tax rate. But, the automatic federal spending cuts - the other half of the fiscal cliff threat - were only deferred, until March. So, we have this continuing drama to entertain and inform us well into 2013...

Here is a brief overview of the major provisions that many of us care about:

Non-Tax Items

one-year extension of emergency unemployment insurance

one-year extension of certain agricultural programs (i.e., preventing the $8/gallon bottle of milk)

postponement of automatic cuts for physician payments from Medicare

Social Security Taxes

temporarily lowered to 4.2% of wages, it is now restored to the previous 6.2% rate

Individual tax rates

All the individual marginal tax rates 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).

Phaseout of itemized deductions and personal exemptions

The personal exemptions and itemized deductions phaseout 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. Relief from AMT for nonrefundable credits is retained.

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 Jan. 1, 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

A number of temporary tax provisions enacted as part of the Bush-era Economic Growth and Tax Relief Reconciliation Act (EGTRRA) were made permanent, including:

Marriage penalty relief (the increased size of the 15% rate bracket and increased standard deduction for married taxpayers filing jointly)

The liberalized 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)

Expanded adoption credit and adoption-assistance program amounts

The exclusion for employer-provided educational assistance

The enhanced rules for student loan deductions introduced by EGTRRA

The employer-provided child care credit

Temporary extensions

A number of individual credits that were set to expire at the end of 2012 were extended through 2017, including the tax credit for qualified tuition and other expenses of higher education, the enhanced provisions of the child tax credit, and the earned income tax credit.

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

Deduction for certain expenses of elementary and secondary school teachers

Exclusion from gross income of discharge of qualified principal residence indebtedness

Deduction of state and local general sales taxes

Above-the-line deduction for qualified tuition and related expenses

Tax-free distributions from individual retirement plans for charitable purposes

Business and Energy Tax Extensions

The act extended many business tax credits, including the section 41 credit for increasing research and development activities. It also extended the increased depreciation expensing amounts under section 179 through 2013, and the availability of an additional 50% first-year bonus depreciation, applying to property placed in service before Jan. 1, 2014 (Jan. 1, 2015, for certain property with longer production periods). The tax credits for Indian employment, Work Opportunity, and hiring active armed forces personnel were all extended, as were many other special interest provisions and energy credits that expired at the end of 2011.

New Taxes

Some new taxes also took effect January 1, as a result of 2010’s health care reform legislation ("ObamaCare").

Additional hospital insurance tax on high-income taxpayers. The employee portion of the hospital insurance tax part of FICA, 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 SECA tax on self-employment income in excess of the threshold amount.

Medicare tax on investment income. Starting January 1, there is now 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 itemized deduction threshold. The threshold for the itemized 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 cafeteria plan years beginning after Dec. 31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for any plan year is $2,500.

All in all, it seems like a lot of obvious extensions and common sense compromises that should not have taken nearly as much time as it did to work out. Really, is there anything here that amounts to more than a band-aid on a deeply-wounded system? What we really want to know is when will the political environment allow for a brave representative or committee to introduce a truly meaningful tax overhaul, incorporating simplification, more progressive fairness, increased taxpayer procedural rights in the dispute process, and the elimination of provisions that lower taxes for some without an attendant stimulation of the economy?

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