At the eleventh hour, Congress averted the tax side of the ominous “Fiscal Cliff” that it faced as 2012 drew to a close. The end result of the intense negotiations was the American Taxpayer Relief Act of 2012 (ATRA).
The most publicized part of ATRA prevented scheduled federal tax rate hikes from going into effect for most taxpayers in 2013, while raising taxes on America’s highest earners. ATRA also keeps in place many expiring income tax breaks and revives some tax increases that had expired over the past several years.
Individual Tax Rates
For tax years beginning after 2012, ATRA makes permanent almost all of the federal income tax rates first put into place in 2001. Those rates otherwise would have increased in 2013. For high‑income taxpayers, a new top tax rate of 39.6%, as opposed to the previous 35%, applies beginning for tax years after 2012.
The new 39.6% rate applies to taxable income above a specified threshold (subject to future adjustments for inflation): $450,000 for married taxpayers filing jointly, $425,000 for heads of households, $400,000 for single taxpayers, and $225,000 for married taxpayers filing separately. The rate schedule is graduated, so taxpayers whose income falls within the 39.6% rate bracket still benefit from the extension of the Bush‑era rates in the lower rate brackets.
Capital Gains and Dividends
In recent years, individual and other noncorporate taxpayers have benefited from a maximum rate of 15% on net capital gains (net long‑term capital gains minus net short‑term capital losses). To the extent the net capital gains would have been taxed at the 10% or 15% tax rate if they had been ordinary income like wages, the net capital gains tax rate has been 0%.
These net capital gains rates for noncorporate taxpayers had been scheduled to be replaced after 2012 by rates up to 20%. ATRA operates to make the 2012 net capital gains rates of 0% and 15% permanent for most taxpayers. A new 20% maximum net capital gains rate applies to taxpayers whose income exceeds the levels mentioned above concerning the 39.6% income tax rate.
In 2012, qualified dividends from domestic corporations and certain foreign corporations were subject to the same maximum rates as net capital gains in 2012 (15% for most taxpayers, 0% if the income would otherwise be taxed in the 10% or 15% income tax brackets). These dividends were to have been taxed as ordinary income starting in 2013, resulting in substantially higher taxes, but ATRA intervened to retain the 2012 dividend rates of 15% and 0% for most taxpayers. As with capital gains, higher income taxpayers whose income exceeds the thresholds set for the 39.6% income tax rate now have a maximum rate of 20% on qualified dividends.
Personal Exemption Phaseout and Limitation of Itemized Deductions
Before 2010, the personal exemptions available to higher income taxpayers were gradually reduced when their adjusted gross income (AGI) exceeded a specific threshold amount. Those higher income individuals also had their allowable itemized tax deductions for the year reduced by up to 80%. By law, the personal exemption phaseout and itemized deduction limitation were gradually reduced, until they were completely removed in 2010. The exemption phaseout and deduction limitation were set to return in 2013. ATRA revives them, at higher threshold levels than had been in place. The end result is that the personal exemption phaseout and itemized deduction limitation will likely affect many more people than just those in the new 39.6% top tax bracket.
ATRA also includes extensions of a variety of individual tax benefits that either expired at the end of 2011, or would have at the end of 2012. Just a few examples of these many benefits are the Child Tax Credit, the State and Local Sales Tax Deduction, the Earned Income Credit, the Coverdell Education Savings Accounts, IRA Distributions to Charities (by persons age 701/2 or older), and the Energy Credit.
Estate and Gift Tax
For 2012, the maximum federal estate‑tax rate was 35%, with an exclusion amount of $5.12 million ($5 million indexed for inflation) that shelters an aggregate amount of transfers at death and lifetime gifts from estate and gift tax. But for ATRA, this top rate and exclusion amount were set to expire after 2012, resulting in a highest tax rate of 55% and an exclusion amount of only $1 million (not indexed for inflation).
ATRA permanently sets the top federal estate tax and gift tax at 40% with an exclusion of $5 million (inflation adjusted) for decedents dying and gifts made after 2012. ATRA also permanently allows “portability” of a decedent’s unused exclusion between spouses.
Included among the other parts of ATRA are provisions that extend the estate‑tax deduction for state estate taxes, qualified conservation easements, and the installment payment of estate tax on closely held businesses. ATRA repeals the 5% surtax on estates larger than $10 million.